In Search of a Risk-Free Asset

Abstract:     
To attract retail time deposits, over 7,000 FDIC insured U.S. commercial banks publicly post their yield offers. I document a sizeable and pro-cyclical cross-sectional dispersion in the yields the banks offered on their insured time deposits during the period 1997 - 2011 revealing the presence of market power for this highly homogeneous financial product. The yields were also adjusted sluggishly and asymmetrically in response to increasing or decreasing fed funds rate target regimes. I investigate to what extent information (search) costs on the part of the investors in this market can explain the observed pricing behavior. I build and estimate an asset pricing model with heterogeneous search cost investors. A large fraction of high information cost investors facing search costs between 10 to 50 basis points rationalizes the observed price dispersion. I further qualitatively match the asymmetric yield rigidity within the framework of costly search without the need to impose menu costs or other restrictions on the banks' repricing behavior.

Number of Pages in PDF File: 52

Keywords: Consumer search, Asset pricing, Retail deposit markets, Price Rigidity, Monetary Policy Transmission, Banking

JEL Classification: D83, D91, G12, G21

working papers series