In this paper we study European banks’ demand for short-term funds (liquidity) during the summer 2007 subprime market crisis. We use bidding data from the European Central Bank’s auctions for one-week loans, their main channel of monetary policy implementation. Through a model of bidding, we show that banks’ behavior reflects their cost of obtaining short-term funds elsewhere (i.e., in the interbank market) as well as a strategic response to other bidders. We find considerable heterogeneity across banks in their willingness to pay for short-term funds supplied in these auctions. Accounting for the strategic component is important: while a naive interpretation of the raw bidding data may suggest that virtually all banks suffered a dramatic increase in the cost of obtaining funds in the interbank market, we find that for about one third of the banks, the change in bidding behavior was simply a strategic response. Using a complementary data set, we also find that banks’ pre-turmoil liquidity costs, as estimated by our model, are predictive of their post-turmoil liquidity costs, and that there is considerable heterogeneity in these costs with respect to the country-of-origin. Finally, among the publicly traded banks, the willingness to pay for short-term funds in the second half of 2007 are predictive of stock prices in late 2008.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
15158.
Length: Date of creation: Jul 2009 Date of revision: Handle: RePEc:nbr:nberwo:15158
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Find related papers by JEL classification: D44 - Microeconomics - - Market Structure and Pricing - - - Auctions D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit G01 - Financial Economics - - General - - - Financial Crises
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