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The impact of the Term Auction Facility on the liquidity risk premium and unsecured interbank spreads

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Abstract

This paper investigates the effectiveness of the Federal Reserve's Term Auction Facility (TAF) in alleviating the liquidity shortage in USD and reducing the spread between the 3-month Libor rate and the expected policy rate. I construct a proxy for the 3-month liquidity risk premium based on data from the FX forward market which enables me to (i) decompose the Libor spread into a liquidity premium and a credit premium, and (ii) test the effectiveness of the TAF in reducing the liquidity premium in money market spreads. I find that long-term (84-day) TAF auctions were effective in reducing the 3-month liquidity premium. Furthermore, a reduction in the liquidity premium led to a fall in the 3-month Libor spread in USD. Credit risk, however, seems to have been a rather modest factor in explaining the increase in the Libor spread during the financial crisis.

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  • Olav Syrstad, 2014. "The impact of the Term Auction Facility on the liquidity risk premium and unsecured interbank spreads," Working Paper 2014/07, Norges Bank.
  • Handle: RePEc:bno:worpap:2014_07
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    File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2014/201407/
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    Cited by:

    1. Kick, Thomas & Koetter, Michael & Storz, Manuela, 2016. "Cross-border transmission of emergency liquidity," Discussion Papers 34/2016, Deutsche Bundesbank.

    More about this item

    Keywords

    Term Auction Facility; liquidity premium; credit premium; Libor-OIS spread;

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers

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