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The effect of the Term Auction Facility on the London Inter-Bank Offered Rate

  • McAndrews, James J.

    (Federal Reserve Bank of New York)

  • Sarkar, Asani

    (Federal Reserve Bank of New York)

  • Wang, Zhenyu

    (Indiana University of Bloomington, Kelley School of Business)

The Term Auction Facility (TAF), the first auction-based liquidity initiative by the Federal Reserve during the 2007–2009 financial crisis, was aimed at improving conditions in the overnight dollar money market and bringing down the significantly elevated London interbank offered rate (Libor). The effectiveness of this innovative policy tool is crucial for understanding the role of the central bank in financial stability, but academic studies disagree on the empirical evidence of the TAF effect on Libor. This paper shows that the disagreement arises from misspecifications of econometric models. Regressions using the daily level of the Libor-OIS spread as the dependent variable suffer from the unit-root problem and produce unreliable test statistics. Those regressions also miss either permanent or temporary TAF effects, depending on the choice of independent variables. In contrast, regressions using the daily change of the Libor-OIS spread are robust to the unit-root problem and the persistence of the TAF effect, consistently producing reliable evidence that the TAF was associated with downward shifts of the Libor-OIS spread. The evidence indicates the efficacy of TAF in helping the interbank market to relieve liquidity strains.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 335.

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Length: 51 pages
Date of creation: 2008
Date of revision: 01 Sep 2015
Handle: RePEc:fip:fednsr:335
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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. Andrew Kuritzkes & Til Schuermann & Scott Weiner, 2005. "Deposit Insurance and Risk Management of the U.S. Banking System: What is the Loss Distribution Faced by the FDIC?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 27(3), pages 217-242, September.
  3. Suresh Sundaresan & Zhenyu Wang, 2006. "Y2K options and the liquidity premium in Treasury bond markets," Staff Reports 266, Federal Reserve Bank of New York.
  4. François-Louis Michaud & Christian Upper, 2008. "What drives interbank rates? Evidence from the Libor panel," BIS Quarterly Review, Bank for International Settlements, March.
  5. Jean Tirole, 2006. "The Theory of Corporate Finance," Post-Print hal-00173191, HAL.
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