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Variable rate liquidity tenders

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  • tuomas välimäki

    (Bank of Finland)

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    Abstract

    This paper constructs an equilibrium model for the short-term money market, when the central bank provides liquidity via variable rate tenders. The relation between market rate of interest and liquidity is derived from a single bank’s profit maximisation problem in the interbank market, and the CB determines its liquidity provision by minimising a quadratic loss function that contains both deviations of expected market rate from CB target rate and differences between liquidity supply and target liquidity. We model equilibrium bid behaviour in the tenders and explain the underbidding phenomenon resulting from the minimum bid rate. We also show that, when maturities of consecutive operations overlap, the expected market interest rate will rise above the CB’s target whenever a target rate change (hike or cut) is expected to occur in the same reserve maintenance period. Finally, we review the data from the ECB variable rate tenders and find that the ECB has been fairly liquidity oriented in its allotment decisions.

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    File URL: http://128.118.178.162/eps/mac/papers/0405/0405010.pdf
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    Bibliographic Info

    Paper provided by EconWPA in its series Macroeconomics with number 0405010.

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    Date of creation: 12 May 2004
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    Handle: RePEc:wpa:wuwpma:0405010

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    Web page: http://128.118.178.162

    Related research

    Keywords: money market tenders; liquidity policy; bidding; central bank operational framework;

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    1. Nyborg, Kjell G. & Strebulaev, Ilya A. & Bindseil, Ulrich, 2002. "Bidding and performance in repo auctions: evidence from ECB open market operations," Working Paper Series 0157, European Central Bank.
    2. Ayuso, Juan & Repullo, Rafael, 2000. "A Model of the Open Market Operations of the European Central Bank," CEPR Discussion Papers 2605, C.E.P.R. Discussion Papers.
    3. Prati, Alessandro & Bartolini, Leonardo & Bertola, Giuseppe, 2003. "The overnight interbank market: Evidence from the G-7 and the Euro zone," Journal of Banking & Finance, Elsevier, vol. 27(10), pages 2045-2083, October.
    4. Bindseil, Ulrich, 2002. "Equilibrium bidding in the Eurosystem's open market operations," Working Paper Series 0137, European Central Bank.
    5. Välimäki, Tuomas, 2001. "Fixed rate tenders and the overnight money market equilibrium," Research Discussion Papers 8/2001, Bank of Finland.
    6. Back, Kerry & Zender, Jaime F, 1993. "Auctions of Divisible Goods: On the Rationale for the Treasury Experiment," Review of Financial Studies, Society for Financial Studies, vol. 6(4), pages 733-64.
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