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Trade Dynamics in the Market for Federal Funds

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  • Ricardo Lagos

    (New York University)

  • Gara Afonson

    (Federal Reserve Bank of New York)

Abstract

We develop a model of the market for federal funds that accounts for the two distinctive features of this market: 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 several policy-relevant issues.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 314.

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Date of creation: 2011
Date of revision:
Handle: RePEc:red:sed011:314

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Fax: 1-314-444-8731
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Web page: http://www.EconomicDynamics.org/society.htm
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  1. Dimitri Vayanos & Pierre-Olivier Weill, 2007. "A search-based theory of the on-the-run phenomenon," LSE Research Online Documents on Economics 24474, London School of Economics and Political Science, LSE Library.
  2. Jianjun Miao, 2006. "A search model of centralized and decentralized trade," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(1), pages 68-92, January.
  3. John Rust & George Hall, 2003. "Middlemen versus Market Makers: A Theory of Competitive Exchange," Journal of Political Economy, University of Chicago Press, vol. 111(2), pages 353-403, April.
  4. Morten L. Bech & Elizabeth Klee, 2009. "The mechanics of a graceful exit: interest on reserves and segmentation in the federal funds market," Staff Reports 416, Federal Reserve Bank of New York.
  5. 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.
  6. Dmitrios Vayanos, 2004. "Search and Endogenous Concentration of Liquidity in Asset Markets," Econometric Society 2004 North American Winter Meetings 647, Econometric Society.
  7. Gara M. Afonso, 2008. "Liquidity and congestion," Staff Reports 349, Federal Reserve Bank of New York.
  8. Pierre-Olivier Weill, 2007. "Leaning Against the Wind," Review of Economic Studies, Oxford University Press, vol. 74(4), pages 1329-1354.
  9. 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.
  10. Gara Afonso & Anna Kovner & Antoinette Schoar, 2010. "Stressed, not frozen: the Federal Funds market in the financial crisis," Staff Reports 437, Federal Reserve Bank of New York.
  11. Bech, Morten L. & Atalay, Enghin, 2008. "The topology of the federal funds market," Working Paper Series 0986, European Central Bank.
  12. 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.
  13. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
  14. Ricardo Lagos & Guillaume Rocheteau, 2007. "Search in asset markets: market structure, liquidity, and welfare," Working Paper 0701, Federal Reserve Bank of Cleveland.
  15. Weill, Pierre-Olivier, 2008. "Liquidity premia in dynamic bargaining markets," Journal of Economic Theory, Elsevier, vol. 140(1), pages 66-96, May.
  16. 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.
  17. Pierre-Olivier Weill & Guillaume Rocheteau & Ricardo Lagos, 2007. "Crashes and Recoveries in Illiquid Markets," 2007 Meeting Papers 981, Society for Economic Dynamics.
  18. 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.
  19. 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).
  20. 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.
  21. Todd Keister & James McAndrews, 2009. "Why are banks holding so many excess reserves?," Staff Reports 380, Federal Reserve Bank of New York.
  22. 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.
  23. Coleman, Wilbur John, II & Gilles, Christian & Labadie, Pamela A, 1996. "A Model of the Federal Funds Market," Economic Theory, Springer, vol. 7(2), pages 337-57, February.
  24. 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.
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Cited by:
  1. 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.
  2. Dimitri Vayanos & Jiang Wang, 2012. "Market Liquidity - Theory and Empirical Evidence," FMG Discussion Papers dp709, Financial Markets Group.
  3. 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.
  4. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
  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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