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Liquidity, information, and the overnight rate

  • Ewerhart, Christian
  • Cassola, Nuno
  • Ejerskov, Steen
  • Valla, Natacha

We model the interbank market for overnight credit with heterogeneous banks and asymmetric information. An unsophisticated bank just trades to compensate its liquidity imbalance, while a sophisticated bank will exploit its private information about the liquidity situation in the market. It is shown that with positive probability, the liquidity effect (Hamilton, 1997) is reversed, i.e., a liquidity drainage from the banking system may generate an overall decrease in the market rate. The phenomenon does not disappear when the number of banks increases. We also show that private information mitigates the effect of an unexpected liquidity shock on the market rate, suggesting a conservative information policy from a central bank perspective. JEL Classification: G14, G21, E52

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Paper provided by European Central Bank in its series Working Paper Series with number 0378.

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Date of creation: Jul 2004
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Handle: RePEc:ecb:ecbwps:20040378
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  1. Campbell, John, 1987. "Money Announcements, The Demand for Bank Reserves, and the Behavior of the Federal Funds Rate within the Statement Week," Scholarly Articles 3220231, Harvard University Department of Economics.
  2. 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.
  3. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  4. James D. Hamilton, 1996. "Measuring the liquidity effect," Working Papers in Applied Economic Theory 96-06, Federal Reserve Bank of San Francisco.
  5. Bhattacharya, Sudipto & Fulghieri, Paolo, 1994. "Uncertain liquidity and interbank contracting," Economics Letters, Elsevier, vol. 44(3), pages 287-294.
  6. Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
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