Precautionary reserves and the interbank market
Liquidity hoarding by banks and extreme volatility of the fed funds rate have been widely seen as severely disrupting the interbank market and the broader financial system during the 2007-08 financial crisis. Using data on intraday account balances held by banks at the Federal Reserve and Fedwire interbank transactions to estimate all overnight fed funds trades, we present empirical evidence on banks' precautionary hoarding of reserves, their reluctance to lend, and extreme fed funds rate volatility. We develop a model with credit and liquidity frictions in the interbank market consistent with the empirical results. Our theoretical results show that banks rationally hold excess reserves intraday and overnight as a precautionary measure against liquidity shocks. Moreover, the intraday fed funds rate can spike above the discount rate and crash to near zero. Apparent anomalies during the financial crisis may be seen as stark but natural outcomes of our model of the interbank market. The model also provides a unified explanation for several stylized facts and makes new predictions for the interbank market.
|Date of creation:||2009|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://www.newyorkfed.org/
More information through EDIRC
|Order Information:|| Web: http://www.ny.frb.org/rmaghome/staff_rp/ Email: |
References listed on IDEAS
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.:
- Quiros, Gabriel Perez & Mendizabal, Hugo Rodriguez, 2006.
"The Daily Market for Funds in Europe: What Has Changed with the EMU?,"
Journal of Money, Credit and Banking,
Blackwell Publishing, vol. 38(1), pages 91-118, February.
- Gabriel Pérez Quirós & Hugo Rodríguez Mendizábal, 2003. "The Daily Market for Funds in Europe: What Has Changed with the EMU?," UFAE and IAE Working Papers 559.03, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
- Gabriel Pérez-Quirós & Hugo Rodríguez Mendizábal, 2003. "The Daily Market for Funds in Europe: What has Changed with the EMU?," Working Papers 22, Barcelona Graduate School of Economics.
- Gabriel Pérez Quirós & Hugo Rodríguez Mendizábal, 2003. "The daily market for funds in Europe: what has changed with the EMU," Banco de Espa�a Working Papers 0313, Banco de Espa�a.
- Aleksander Berentsen & Cyril Monet, 2006.
"Monetary Policy in a Channel System,"
IEW - Working Papers
295, Institute for Empirical Research in Economics - University of Zurich.
- Huberto M. Ennis & John A. Weinberg, 2007. "Interest on reserves and daylight credit," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 111-142.
- James McAndrews & Asani Sarkar & Zhenyu Wang, 2008. "The effect of the Term Auction Facility on the London Inter-Bank Offered Rate," Staff Reports 335, Federal Reserve Bank of New York.
- Adam Ashcraft & Hoyt Bleakley, 2006. "On the market discipline of informationally opaque firms: evidence from bank borrowers in the federal funds market," Staff Reports 257, Federal Reserve Bank of New York.
- Allen, Linda & Peristiani, Stavros & Saunders, Anthony, 1989. "Bank Size, Collateral, and Net Purchase Behavior in the Federal Funds Market: Empirical Evidence," The Journal of Business, University of Chicago Press, vol. 62(4), pages 501-15, October.
- Allen, Linda & Saunders, Anthony, 1986. "The large-small bank dichotomy in the federal funds market," Journal of Banking & Finance, Elsevier, vol. 10(2), pages 219-230, June.
- Adam B. Ashcraft & Darrell Duffie, 2007. "Systemic Illiquidity in the Federal Funds Market," American Economic Review, American Economic Association, vol. 97(2), pages 221-225, May.
- Furfine, Craig H., 2000. "Interbank payments and the daily federal funds rate," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 535-553, October.
When requesting a correction, please mention this item's handle: RePEc:fip:fednsr:370. 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: (Amy Farber)
If references are entirely missing, you can add them using this form.