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Liquidity, Information, and the Overnight Rate

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  • Christian Ewerhart
  • Nuno Cassola
  • Steen Ejerskov
  • Natacha Valla

Abstract

We model the interbank market for overnight credit with heterogeneous banks and asymmetric information. An unsophisticated bank just trades to compensate its liquidity imbalance, while a sophisticated bank will exploit its private information about the liquidity situation in the market. It is shown that with positive probability, the liquidity effect (Hamilton, 1997) is reversed, i.e., a liquidity drainage from the banking system may generate an overall decrease in the market rate. The phenomenon does not disappear when the number of banks increases. We also show that private information mitigates the effect of an unexpected liquidity shock on the market rate, suggesting a conservative information policy from a central bank perspective.

Suggested Citation

  • Christian Ewerhart & Nuno Cassola & Steen Ejerskov & Natacha Valla, "undated". "Liquidity, Information, and the Overnight Rate," IEW - Working Papers 186, Institute for Empirical Research in Economics - University of Zurich.
    • Handle: RePEc:zur:iewwpx:186
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    File URL: https://www.zora.uzh.ch/id/eprint/52082/1/iewwp186.pdf
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    References listed on IDEAS

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    5. 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.
    6. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
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    Cited by:

    1. Schanz, Jochen, 2009. "How do different models of foreign exchange settlement influence the risks and benefits of global liquidity management?," Bank of England working papers 374, Bank of England.
    2. Grzegorz Haᴌaj & Christoffer Kok, 2015. "Modelling the emergence of the interbank networks," Quantitative Finance, Taylor & Francis Journals, vol. 15(4), pages 653-671, April.
    3. Bruno S. Frey & Simon Luechinger & Alois Stutzer, 2007. "Calculating Tragedy: Assessing The Costs Of Terrorism," Journal of Economic Surveys, Wiley Blackwell, vol. 21(1), pages 1-24, February.
    4. Bruno Frey, 2005. "‘‘Just forget it.’’ Memory distortions as bounded rationality," Mind & Society: Cognitive Studies in Economics and Social Sciences, Springer;Fondazione Rosselli, vol. 4(1), pages 13-25, June.
    5. George Mountis, 2012. "Banks’ Domestic & Cross-border M&As: Where Can They Go Wrong?," Cyprus Economic Policy Review, University of Cyprus, Economics Research Centre, vol. 6(1), pages 39-67, June.
    6. Marius Jurgilas, 2005. "Interbank market under the currency board: Case of Lithuania," Computing in Economics and Finance 2005 448, Society for Computational Economics.
    7. Marius Jurgilas, 2006. "Interbank Markets under Currency Boards," Working papers 2006-19, University of Connecticut, Department of Economics.
    8. Moschitz, Julius, 2004. "The determinants of the overnight interest rate in the euro area," Working Paper Series 393, European Central Bank.

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    More about this item

    Keywords

    Liquidity effect; asymmetric information; monetary policy implementation;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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