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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
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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
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Web page: http://www.EconomicDynamics.org/society.htm
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References

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  1. Spulber, Daniel F, 1996. "Market Making by Price-Setting Firms," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 559-80, October.
  2. Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2007. "Crashes and recoveries in illiquid markets," Working Paper 0708, Federal Reserve Bank of Cleveland.
  3. 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.
  4. Viral V. Acharya & Ouarda Merrouche, 2010. "Precautionary Hoarding of Liquidity and Inter-Bank Markets: Evidence from the Sub-prime Crisis," NBER Working Papers 16395, National Bureau of Economic Research, Inc.
  5. 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.
  6. Jianjun Miao, 2004. "A Search Model of Centralized and Decentralized Trade," Microeconomics 0410003, EconWPA.
  7. Dimitri Vayanos & Pierre-Olivier Weill, 2006. "A Search-Based Theory of the On-the-Run Phenomenon," NBER Working Papers 12670, National Bureau of Economic Research, Inc.
  8. Gara M. Afonso, 2008. "Liquidity and congestion," Staff Reports 349, Federal Reserve Bank of New York.
  9. Vayanos, Dimitri & Wang, Tan, 2007. "Search and endogenous concentration of liquidity in asset markets," Journal of Economic Theory, Elsevier, vol. 136(1), pages 66-104, September.
  10. Morten L. Bech & Enghin Atalay, 2008. "The topology of the federal funds market," Staff Reports 354, Federal Reserve Bank of New York.
  11. Ricardo Lagos, 2009. "Asset Prices, Liquidity, and Monetary Policy in an Exchange Economy," 2009 Meeting Papers 390, Society for Economic Dynamics.
  12. Huberto Ennis & John Weinberg, 2013. "Over-the-counter loans, adverse selection, and stigma in the interbank market," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(4), pages 601-616, October.
  13. 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.
  14. Ricardo Lagos, 2005. "Asset Prices and Liquidity in an Exchange Economy," 2005 Meeting Papers 143, Society for Economic Dynamics.
  15. 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.
  16. 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.
  17. John Rust & George Hall, 2002. "Middlemen versus Market Makers: A Theory of Competitive Exchange," NBER Working Papers 8883, National Bureau of Economic Research, Inc.
  18. 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.
  19. 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.
  20. 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.
  21. Weill, Pierre-Olivier, 2008. "Liquidity premia in dynamic bargaining markets," Journal of Economic Theory, Elsevier, vol. 140(1), pages 66-96, May.
  22. Pierre-Olivier Weill, 2004. "Leaning against the wind," 2004 Meeting Papers 382, Society for Economic Dynamics.
  23. 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.
  24. 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).
  25. Ann-Marie Meulendyke, 1998. "U.S. monetary policy and financial markets," Monograph, Federal Reserve Bank of New York, number 1998mpaf.
  26. Morten L. Bech & Elizabeth Klee, 2010. "The mechanics of a graceful exit: interest on reserves and segmentation in the federal funds market," Finance and Economics Discussion Series 2010-07, Board of Governors of the Federal Reserve System (U.S.).
  27. Todd Keister & James McAndrews, 2009. "Why are banks holding so many excess reserves?," Staff Reports 380, Federal Reserve Bank of New York.
  28. 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.
  29. Huberto M. Ennis & Todd Keister, 2008. "Understanding monetary policy implementation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 235-263.
  30. 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.
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Cited by:
  1. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
  2. 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.
  3. Dimitri Vayanos & Jiang Wang, 2012. "Market Liquidity - Theory and Empirical Evidence," FMG Discussion Papers dp709, Financial Markets Group.
  4. Aleksander Berentsen & Alessandro Marchesiani & Christopher J. Waller, 2013. "Floor systems for implementing monetary policy: Some unpleasant fiscal arithmetic," ECON - Working Papers 121, Department of Economics - University of Zurich, revised Sep 2013.
  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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