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The Overnight Rate of Interest under Averaged Reserve Requirements

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  • Välimäki, Tuomas

    ()
    (Bank of Finland)

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    Abstract

    Averaging the reserve requirement is often considered an efficient way to reduce volatility at the very short end of the money market yield curve. The Bank of Finland began to apply an averaging provision at the beginning of October 1995. Notably, the volatility of the overnight rate of interest in the Finnish money markets has increased since the start of the averaging scheme. This paper builds up a simple model of the determination of the overnight rate of interest. The effects of both the averaging scheme and the central bank's reaction to the bids it receives in money market tenders are evaluated against the model. The paper ends with an evaluation of the empirical evidence from the first two years that have passed since the introduction of the averaging provision in Finland.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/DP_07_1998.pdf
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    Bibliographic Info

    Paper provided by Bank of Finland in its series Research Discussion Papers with number 7/1998.

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    Length: 38 pages
    Date of creation: 27 Apr 1998
    Date of revision:
    Handle: RePEc:hhs:bofrdp:1998_007

    Contact details of provider:
    Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/
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    Related research

    Keywords: money market tenders; minimum reserves; liquidity; averaging; convexity; interest rate volatility;

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    1. Modigliani, Franco & Rasche, Robert & Cooper, J Philip, 1970. "Central Bank Policy, the Money Supply, and the Short-Term Rate of Interest," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 2(2), pages 166-218, May.
    2. Lippman, Steven A & McCall, John J, 1986. "An Operational Measure of Liquidity," American Economic Review, American Economic Association, vol. 76(1), pages 43-55, March.
    3. 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.
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