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Federal‐funds‐rate volatility and the reserve‐maintenance period

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  • David Eagle

Abstract

The day‐to‐day changes in the federal funds rate affects all banks, in particular those banks who execute their single federal funds transaction through larger correspondent banks. This paper's stochastic equilibrium model discusses how a major determinant of that behavior—the bank's reserve‐maintenance period—molds the interday pattern of federal‐funds‐rate volatility. In particular, the model explains why the volatility of the federal funds rate increases from the beginning to the end of that period. While Spindt and Hoffmeister (1988) tried to explain that increases in terms of transaction‐cost avoidance, this paper's model demonstrates that rational expectations alone will generate this effect. It also shows that lengthening the reserve‐maintenance period increases federal‐funds rate volatility on the last day of the period.

Suggested Citation

  • David Eagle, 1995. "Federal‐funds‐rate volatility and the reserve‐maintenance period," Review of Financial Economics, John Wiley & Sons, vol. 4(2), pages 157-170, March.
    • Handle: RePEc:wly:revfec:v:4:y:1995:i:2:p:157-170
    DOI: 10.1016/1058-3300(95)90004-7
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    References listed on IDEAS

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    1. Spindt, Paul A. & Hoffmeister, J. Ronald, 1988. "The Micromechanics of the Federal Funds Market: Implications for Day-of-the-Week Effects in Funds Rate Variability," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 23(4), pages 401-416, December.
    2. William Poole, 1968. "Commercial Bank Reserve Management In A Stochastic Model: Implications For Monetary Policy," Journal of Finance, American Finance Association, vol. 23(5), pages 769-791, December.
    3. Vickson, R. G., 1985. "Simple Optimal Policy for Cash Management: The Average Balance Requirement Case," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(3), pages 353-369, September.
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