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Trade dynamics in the market for federal funds

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  • Gara Afonso
  • Ricardo Lagos

Abstract

We develop a model of the market for federal funds that explicitly accounts for its two distinctive features: banks have to search for a suitable counterparty, and once they have met, both parties negotiate the size of the loan and the repayment. The theory is used to answer a number of positive and normative questions: What are the determinants of the fed funds rate? How does the market reallocate funds? Is the market able to achieve an efficient reallocation of funds? We also use the model for theoretical and quantitative analyses of policy issues facing modern central banks.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 549.

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Date of creation: 2012
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Handle: RePEc:fip:fednsr:549

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Keywords: Federal funds market (United States) ; Econometric models ; Bank loans ; Federal funds rate ; Banks and banking; Central ; Monetary policy ; Over-the-counter markets;

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  1. Gara Afonso & Anna Kovner & Antoinette Schoar, 2011. "Stressed, Not Frozen: The Federal Funds Market in the Financial Crisis," Journal of Finance, American Finance Association, vol. 66(4), pages 1109-1139, 08.
  2. Hamilton, James D, 1996. "The Daily Market for Federal Funds," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 26-56, February.
  3. Christian Gilles & Pamela A. Labadie & Wilbur John Coleman II., 1996. "A model of the federal funds market," Economic Theory, Springer, vol. 7(2), pages 337-357.
  4. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
  5. Todd Keister & Antoine Martin & James McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 41-56.
  6. Pierre-Olivier Weill, 2007. "Leaning Against the Wind," Review of Economic Studies, Oxford University Press, vol. 74(4), pages 1329-1354.
  7. Gara M. Afonso, 2008. "Liquidity and congestion," Staff Reports 349, Federal Reserve Bank of New York.
  8. Jianjun Miao, 2005. "A Search Model of Centralzied and Decentralized Trade," Boston University - Department of Economics - The Institute for Economic Development Working Papers Series dp-144, Boston University - Department of Economics.
  9. John Rust & George Hall, 2002. "Middlemen versus Market Makers: A Theory of Competitive Exchange," NBER Working Papers 8883, National Bureau of Economic Research, Inc.
  10. Huberto M. Ennis & Todd Keister, 2008. "Understanding monetary policy implementation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 235-263.
  11. Dimitri Vayanos & Pierre-Olivier Weill, 2005. "A search-based theory of the on-the-run phenomenon," LSE Research Online Documents on Economics 459, London School of Economics and Political Science, LSE Library.
  12. Ricardo Lagos, 2009. "Asset Prices, Liquidity, and Monetary Policy in an Exchange Economy," 2009 Meeting Papers 390, Society for Economic Dynamics.
  13. Huberto M. Ennis & John A. Weinberg, 2010. "Over-the-counter loans, adverse selection, and stigma in the interbank market," Working Paper 10-07, Federal Reserve Bank of Richmond.
  14. Bech, Morten L. & Atalay, Enghin, 2008. "The topology of the federal funds market," Working Paper Series 0986, European Central Bank.
  15. Paul Bennett & Spence Hilton, 1997. "Falling reserve balances and the federal funds rate," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 3(May).
  16. Lagos, Ricardo, 2010. "Some results on the optimality and implementation of the Friedman rule in the Search Theory of Money," Journal of Economic Theory, Elsevier, vol. 145(4), pages 1508-1524, July.
  17. Weill, Pierre-Olivier, 2008. "Liquidity premia in dynamic bargaining markets," Journal of Economic Theory, Elsevier, vol. 140(1), pages 66-96, May.
  18. Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2008. "Crashes and Recoveries in Illiquid Markets," NBER Working Papers 14119, National Bureau of Economic Research, Inc.
  19. Adam B. Ashcraft & Darrell Duffie, 2007. "Systemic Illiquidity in the Federal Funds Market," American Economic Review, American Economic Association, vol. 97(2), pages 221-225, May.
  20. Viral V. Acharya & Ouarda Merrouche, 2013. "Precautionary Hoarding of Liquidity and Interbank Markets: Evidence from the Subprime Crisis," Review of Finance, European Finance Association, vol. 17(1), pages 107-160.
  21. Bech, Morten L. & Klee, Elizabeth, 2011. "The mechanics of a graceful exit: Interest on reserves and segmentation in the federal funds market," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 415-431.
  22. Dimitri Vayanos & Tan Wang, 2004. "Search and endogenous concentration of liquidity in asset markets," LSE Research Online Documents on Economics 455, London School of Economics and Political Science, LSE Library.
  23. Spulber, Daniel F, 1996. "Market Making by Price-Setting Firms," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 559-80, October.
  24. Ricardo Lagos & Guillaume Rocheteau, 2007. "Search in Asset Markets: Market Structure, Liquidity, and Welfare," American Economic Review, American Economic Association, vol. 97(2), pages 198-202, May.
  25. William Poole, 1968. "Commercial Bank Reserve Management In A Stochastic Model: Implications For Monetary Policy," Journal of Finance, American Finance Association, vol. 23(5), pages 769-791, December.
  26. Gara Afonso & Anna Kovner & Antoinette Schoar, 2010. "Stressed not Frozen: The Fed Funds Market in the Financial Crisis," NBER Working Papers 15806, National Bureau of Economic Research, Inc.
  27. Ann-Marie Meulendyke, 1998. "U.S. monetary policy and financial markets," Monograph, Federal Reserve Bank of New York, number 1998mpaf.
  28. Ho, Thomas S Y & Saunders, Anthony, 1985. " A Micro Model of the Federal Funds Market," Journal of Finance, American Finance Association, vol. 40(3), pages 977-88, July.
  29. Huberto M. Ennis & Alexander L. Wolman, 2010. "Excess reserves and the new challenges for monetary policy," Richmond Fed Economic Brief, Federal Reserve Bank of Richmond, issue Mar.
  30. Todd Keister & James J. McAndrews, 2009. "Why are banks holding so many excess reserves?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 15(Dec).
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Citations

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Cited by:
  1. Dimitri Vayanos & Jiang Wang, 2012. "Market Liquidity — Theory and Empirical Evidence," NBER Working Papers 18251, National Bureau of Economic Research, Inc.
  2. Aleksander Berentsen & Alessandro Marchesiani & Christopher Waller, 2014. "Floor Systems for Implementing Monetary Policy: Some Unpleasant Fiscal Arithmetic," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(3), pages 523-542, July.
  3. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
  4. Jason Allen & James Chapman & Federico Echenique & Matthew Shum, 2012. "Efficiency and Bargaining Power in the Interbank Loan Market," Working Papers 12-29, Bank of Canada.
  5. Wright, Randall & Trejos, Alberto, 2014. "Search-Based Models of Money and Finance: An Integrated Approach," Working Papers 709, Federal Reserve Bank of Minneapolis.

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