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Liquidity Crunch in Late 2008: High-Frequency Differentials between Forward-Implied Funding Costs and Money Market Rates

Author

Listed:
  • Matthew S. Yiu

    (Hong Kong Monetary Authority)

  • Joseph K. W. Fung

    (Hong Kong Baptist University and Hong Kong Institute for Monetary Research)

  • Lu Jin

    (Hong Kong Monetary Authority)

  • Wai-Yip Alex Ho

    (Hong Kong Monetary Authority and Boston University)

Abstract

The US Federal Reserve and the European Central Bank have adopted a number of measures, including aggressive policy rate cuts, to ease the liquidity crunch in the financial markets following the collapse of Lehman Brothers. Using high frequency spot and forward foreign exchange and interest rate quotes that are potentially executable for the period surrounding the 2008 global financial turmoil, this study examines the variations of intraday funding liquidity across the global financial markets that span different time zones. Moreover, the paper also tests how and to what extent policy actions undertaken by central banks affect the dynamics of market liquidity conditions. Similar to Hui et al. (2009), the paper uses the differential between the US dollar interest rate implied by the covered interest rate parity condition and the corresponding US dollar interest rate as a proxy for the liquidity (or the lack of it) in the US dollar money market. The study focuses on the EUR/USD exchange rate and compares the most stressful crisis period with other relatively less stressful periods. The intraday funding liquidity condition during the most tumultuous period shows that the pressures in the demand for US dollars through foreign exchange and forward markets spilled over to the Asian markets. The paper also examines how policy announcements by the central banks affect the dynamics of market liquidity. The study employs autoregressive models to capture the potential effects of monetary policy announcements on both the mean and volatility of the liquidity proxy. The empirical results show that the coordinated cuts of policy rates failed to stimulate lending in the short-term US money market, whereas the uncapped currency swap lines offered by the Federal Reserve to other central banks succeeded in easing the liquidity condition in the market. The policy is more effective and persistent for the very short end of the money market.

Suggested Citation

  • Matthew S. Yiu & Joseph K. W. Fung & Lu Jin & Wai-Yip Alex Ho, 2010. "Liquidity Crunch in Late 2008: High-Frequency Differentials between Forward-Implied Funding Costs and Money Market Rates," Working Papers 262010, Hong Kong Institute for Monetary Research.
    • Handle: RePEc:hkm:wpaper:262010
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    References listed on IDEAS

    as
    1. Cho‐Hoi Hui & Hans Genberg & Tsz‐Kin Chung, 2011. "Funding liquidity risk and deviations from interest‐rate parity during the financial crisis of 2007–2009," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 16(4), pages 307-323, October.
    2. Bank for International Settlements, 2010. "The functioning and resilience of cross-border funding markets," CGFS Papers, Bank for International Settlements, number 37, december.
    3. Tommaso Mancini Griffoli & Angelo Ranaldo, 2010. "Limits to arbitrage during the crisis: funding liquidity constraints and covered interest parity," Working Papers 2010-14, Swiss National Bank.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Financial Crisis; Intraday Liquidity; CIP Deviation; Monetary Policy;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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