Trade Dynamics in the Market for Federal Funds

Abstract

We develop a model of the market for federal funds that explicitly accounts for its two distinctive features: banks have to search for a suitable counterparty, and once they meet, both parties negotiate the size of the loan and the repayment. The theory is used to answer a number of positive and normative questions: What are the determinants of the fed funds rate? How does the market reallocate funds? Is the market able to achieve an efficient reallocation of funds? We also use the model for theoretical and quantitative analyses of policy issues facing modern central banks.

Pricing and Liquidity in Decentralized Asset Markets

“…If there were no heterogeneity in or in , the quantity traded in a bilateral meeting would depend only on pre-trade asset positions as in Afonso and Lagos (2015). In this sense, my model generalizes the trading rule of Afonso and Lagos (2015) by showing that, in my more general model, it depends also on preference parameters (r, , D and ) and search e¢ ciency parameters ( , , 0 ).…”

“…To the 4 See Du¢ e (2012b). 5 The framework of Du¢ e et al (2005) has also been adopted to analyze a number of issues, such as market fragmentation (Miao, 2006), clientele e¤ects (Vayanos & Wang, 2007), the congestion e¤ect (Afonso, 2011), commercial aircraft leasing (Gavazza, 2011), liquidity in corporate bond market (He & Milbradt, 2014), the co-existence of illiquid and liquid markets (Praz, 2014), the liquidity spillover between bond and CDS markets (Sambalaibat, 2015), the supply of liquid assets (Geromichalos & Herrenbrueck, 2016), and the endogenous bargaining delays (Tsoy, 2016).…”

“…They show that banks with average asset holdings endogenously become "middlemen" of the market by buying from banks with excess reserves and selling to banks with low reserves. Relative to Afonso and Lagos (2015), my contribution is to solve for a stochastic steady-state with two new dimensions of heterogeneity: hedging need and search intensity. As I explain above, these are important for explaining stylized OTC market facts and obtaining new policy implications.…”

“…It is commonly agreed that the Volcker rule e¤ectively reduces the ability of intermediaries to provide liquidity. 4 Accordingly, in my model, I capture this in a stylized way by a mean-preserving contraction in search intensities. My model predicts di¤erent welfare impacts for di¤erent markets.…”

The Bank for International Settlement

“…This scenario includes a partial loss of retail deposits, significant loss of unsecured and secured wholesale funding, contractual outflows from derivative positions associated with a three-notch ratings downgrade, and substantial calls on off-balance sheet exposures. The calibration of scenario run-off rates reflects a combination of 1 Central bank reserves held to meet reserve requirements may be included in HQLA, to the extent that these reserves can be drawn down in times of stress. The LCR rules text states that "[l]ocal supervisors should discuss and agree with the relevant central bank the extent to which central bank reserves should count towards the stock of liquid assets, i.e., the extent to which reserves are able to be drawn down in times of stress".…”