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The 2007 Subprime Market Crisis Through the Lens of European Central Bank Auctions for Short-Term Funds

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  • Nuno Cassola

    (European Central Bank)

  • Ali Hortacsu

    (Department of Economics, University of Chicago)

  • Jakub Kastl

    ()
    (Department of Economics, Stanford Univeristy)

Abstract

In this paper we study European banks’ demand for short-term funds during the 2007 subprime market crisis. We use bidding data from the European Central Bank’s auctions for one-week loans. Through a model of bidding, we show that bank behavior reflects the cost of obtaining short-term funds elsewhere 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 dataset, we also find that bank 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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Bibliographic Info

Paper provided by Stanford Institute for Economic Policy Research in its series Discussion Papers with number 08-039.

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Date of creation: Jul 2009
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Handle: RePEc:sip:dpaper:08-039

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Keywords: multiunit auctions; primary market; structural estimation; subprime market; liquidity crisis;

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References

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  1. John B. Taylor & John C. Williams, 2008. "A black swan in the money market," Working Paper Series 2008-04, Federal Reserve Bank of San Francisco.
  2. Ewerhart, Christian & Tapking, Jens, 2008. "Repo markets, counterparty risk and the 2007/2008 liquidity crisis," Working Paper Series 0909, European Central Bank.
  3. Eisenschmidt, Jens & Hirsch, Astrid & Linzert, Tobias, 2009. "Bidding behaviour in the ECB’s main refinancing operations during the financial crisis," Working Paper Series 1052, European Central Bank.
  4. Acharya, Viral V. & Schnabl, Philipp & Suarez, Gustavo, 2013. "Securitization without risk transfer," Journal of Financial Economics, Elsevier, vol. 107(3), pages 515-536.
  5. Eisenschmidt, Jens & Tapking, Jens, 2009. "Liquidity risk premia in unsecured interbank money markets," Working Paper Series 1025, European Central Bank.
  6. Christian Ewerhart & Nuno Cassola & Natacha Valla, 2007. "Declining Valuations And Equilibrium Bidding In Central Bank Refinancing Operations," Swiss Finance Institute Research Paper Series 07-22, Swiss Finance Institute.
  7. Kjell G. Nyborg & Ulrich Bindseil & Ilya A. Strebulaev, 2005. "Bidding and Performance in Repo Auctions: Evidence from ECB Open Market Operations," Working Papers 2005.92, Fondazione Eni Enrico Mattei.
  8. Lutz G. Arnold & John G. Riley, 2009. "On the Possibility of Credit Rationing in the Stiglitz-Weiss Model," American Economic Review, American Economic Association, vol. 99(5), pages 2012-21, December.
  9. Adam Ashcraft & Morten L. Bech & W. Scott Frame, 2009. "The Federal Home Loan Bank System: the lender of next-to-last resort?," Working Paper 2009-04, Federal Reserve Bank of Atlanta.
  10. Breusch, T S & Pagan, A R, 1980. "The Lagrange Multiplier Test and Its Applications to Model Specification in Econometrics," Review of Economic Studies, Wiley Blackwell, vol. 47(1), pages 239-53, January.
  11. Athey, Susan & Haile, Philip A., 2007. "Nonparametric Approaches to Auctions," Handbook of Econometrics, in: J.J. Heckman & E.E. Leamer (ed.), Handbook of Econometrics, edition 1, volume 6, chapter 60 Elsevier.
  12. Kastl, Jakub, 2012. "On the properties of equilibria in private value divisible good auctions with constrained bidding," Journal of Mathematical Economics, Elsevier, vol. 48(6), pages 339-352.
  13. François-Louis Michaud & Christian Upper, 2008. "What drives interbank rates? Evidence from the Libor panel," BIS Quarterly Review, Bank for International Settlements, March.
  14. Ethan Cohen-Cole & Burcu Duygan-Bump & José Fillat & Judit Montoriol-Garriga, 2008. "Looking behind the aggregates: a reply to “Facts and Myths about the Financial Crisis of 2008”," Risk and Policy Analysis Unit Working Paper QAU08-5, Federal Reserve Bank of Boston.
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Citations

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Cited by:
  1. Xavier Vives, 2009. "Strategic Supply Function Competition with Private Information," CESifo Working Paper Series 2856, CESifo Group Munich.
  2. Massimiliano Affinito, 2013. "Central bank refinancing, interbank markets, and the hypothesis of liquidity hoarding: evidence from a euro-area banking system," Temi di discussione (Economic working papers) 928, Bank of Italy, Economic Research and International Relations Area.
  3. Galina Hale & Maurice Obstfeld, 2014. "The Euro and The Geography of International Debt Flows," NBER Working Papers 20033, National Bureau of Economic Research, Inc.
  4. Xavier Vives, 2011. "A Large-Market Rational Expectations Equilibrium Model," CESifo Working Paper Series 3485, CESifo Group Munich.
  5. Raddatz, Claudio, 2010. "When the rivers run dry : liquidity and the use of wholesale funds in the transmission of the U.S. subprime crisis," Policy Research Working Paper Series 5203, The World Bank.
  6. Jason Allen & Ali Hortaçsu & Jakub Kastl, 2011. "Analyzing Default Risk and Liquidity Demand during a Financial Crisis: The Case of Canada," Working Papers 11-17, Bank of Canada.

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