Testing Information Diffusion in the Decentralized Unsecured Market for Euro Funds

Abstract

Average rates in the decentralized unsecured market for euro funds, like the EONIA for the overnight maturity, are fundamental indicators of the smooth transmission of the signal rate by the central bank. Public information plays an important role in this context, as key interest rates are set by the central bank and average market rates are published daily, constituting common knowledge. Nevertheless, according to the theoretical literature on over-the-counter markets, private information may have an important role in a decentralized market. The diffusion of private information can generate prices that depend on the decentralized market structure. This is the first paper to use an ad hoc (network) version of the spatial autoregressive model to assess the presence of this mechanism. I propose a simple methodology to test whether the joint distribution of rates depends on the interbank network structure and to estimate information diffusion strength. The method is applied to a unique dataset collecting unsecured interbank loans and characteristics of banks operating in European central bank money. A wide time span including sovereign debt crises in the euro area is considered. I find that information diffusion played a greater role during periods dominated by strong uncertainty.

Keywords: interbank markets, money, trading networks, payment systems, information aggregation, spatial autoregressive models, bilateral trading

JEL Classification: E52, E40, C21, G21, D40