Probability of informed trading on the euro overnight market rate

Abstract

In this paper the probability of informed trading (PIN) model developed by Easley and O'Hara is applied to analyse the role and impact of heterogeneities in the euro overnight unsecured market. The empirical assessment of the functioning of this market is based on the PIN that measures the ability of traders to interpret signals on the expected evolution of the overnight rate. Results show that between 2000 and 2004 a heterogeneous learning process of market mechanisms within participants could be observed, whereas such asymmetries have been sharply decreasing since 2005. This is reviewed against some significant events that occurred in the euro money market, such as the reform of the Eurosystem's operational framework in March 2004 and the recent financial market turmoil, which has represented a break in the steady decline of asymmetries as evidence suggest.

Asymmetric information and term lending in the Euro money market: Evidence from the beginning of the turmoil

“…These considerations suggest that the pricing of interbank loans has become more stable in correspondence with a wider heterogeneity in the banking system. 6 These patterns are similar to those documented by Idier and Nardelli (2011) for the overnight segment. The intuition for these results is that the reform has contributed to the creation of a larger pool of banks capable of understanding the developments of the market.…”

“…Rather, it arises from funding obligations contracted by banks. While Idier and Nardelli (2011) stress the role of short-lived and overnight shocks to the demand for cash, we suggest that the relation between demand and supply of interbank deposits with maturity above one month is determined by systematic patterns. These patterns are related both to constraints of institutional nature, and to rational choices made by banks.…”

“…A recent application to the overnight segment of the Euro money market is provided by Idier and Nardelli (2011). The institutional framework of the money market requires banks to hold reserves over a given period of time, called the reserve maintenance period.…”

“…Consistently with Idier and Nardelli (2011), we assume that the demand for funds in excess of the supply is driven by the inventory constraints characterizing banks' balance sheets. In other words, the demand for money is not determined by the attractivity of the asset in terms of yields.…”

“…Section 5 presents some concluding remarks. Idier and Nardelli (2011) suggest that two key features of the money market should be considered to understand the role of information. The first factor is that banks that pursue active trading can have an impact on the aggregate demand for money.…”