Arbitrage, liquidity and exit: the repo and federal funds markets before, during, and emerging from the financial crisis
This paper examines the link between the federal funds and repo markets, before, during, and emerging from the financial crisis that began in August 2007. In particular, the paper investigates the initial transmission of monetary policy to closely related money markets, pricing of risk, and liquidity effects, and then shows how these could interact if the Federal Reserve removes the substantial amount of liquidity currently in the federal funds market. The results suggest that pass-through from the federal funds rate to the repo deteriorated somewhat during the zero lower bound period, likely due to limits to arbitrage and idiosyncratic market factors. In addition, during the early part of the crisis, the pricing of federal funds, which are unsecured loans, indicated a marked jump in perceived credit risk. Moreover, the liquidity effect for the federal funds rate, or the change in the federal funds rate associated with an exogenous change in reserve balances, weakened greatly with the increase in supply of these balances over the crisis, implying a non-linear demand for federal funds. Using these analyses, the paper then shows simulations of the dynamic effects and balance sheet mechanics of liquidity draining on the federal funds and repo rates--a tool that might be used in an exit strategy to tighten monetary policy.
|Date of creation:||2012|
|Date of revision:|
|Contact details of provider:|| Postal: 20th Street and Constitution Avenue, NW, Washington, DC 20551|
Web page: http://www.federalreserve.gov/
More information through EDIRC
|Order Information:||Web: http://www.federalreserve.gov/pubs/feds/fedsorder.html|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Michael J. Fleming & Kenneth D. Garbade, 2005. "Explaining settlement fails," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 11(Sep).
- Thornton, Daniel L., 2005.
"Tests of the expectations hypothesis: Resolving the anomalies when the short-term rate is the federal funds rate,"
Journal of Banking & Finance,
Elsevier, vol. 29(10), pages 2541-2556, October.
- Daniel L. Thornton, 2004. "Tests of the expectations hypothesis: resolving the anomalies when the short-term rate is the federal funds rate," Working Papers 2000-003, Federal Reserve Bank of St. Louis.
- Michael J. Fleming & Warren B. Hrung & Frank M. Keane, 2010.
"Repo Market Effects of the Term Securities Lending Facility,"
American Economic Review,
American Economic Association, vol. 100(2), pages 591-96, May.
- Michael J. Fleming & Warren B. Hrung & Frank M. Keane, 2010. "Repo market effects of the Term Securities Lending Facility," Staff Reports 426, Federal Reserve Bank of New York.
- Leonardo Bartolini & Spence Hilton & Suresh Sundaresan & Christopher Tonetti, 2011. "Collateral Values by Asset Class: Evidence from Primary Securities Dealers," Review of Financial Studies, Society for Financial Studies, vol. 24(1), pages 248-278.
- Johansen, Soren, 1995. "Identifying restrictions of linear equations with applications to simultaneous equations and cointegration," Journal of Econometrics, Elsevier, vol. 69(1), pages 111-132, September.
- Scott Happ, 1986. "The Behavior of Rates on Federal Funds and Repurchase Agreements," The American Economist, Omicron Delta Epsilon, vol. 30(2), pages 22-32, October.
- Niall Coffey & Warren B. Hrung & Asani Sarkar, 2009. "Capital constraints, counterparty risk, and deviations from covered interest rate parity," Staff Reports 393, Federal Reserve Bank of New York.
- Milton Friedman & Anna J. Schwartz, 1963. "A Monetary History of the United States, 1867–1960," NBER Books, National Bureau of Economic Research, Inc, number frie63-1, May.
When requesting a correction, please mention this item's handle: RePEc:fip:fedgfe:2012-21. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marlene Vikor)
If references are entirely missing, you can add them using this form.