Precautionary Reserves and the Interbank Market

54 Pages Posted: 22 Mar 2009

See all articles by Adam B. Ashcraft

Adam B. Ashcraft

Federal Reserve Bank of New York

James McAndrews

Wharton Financial Institutions Center

David R. Skeie

University of Warwick - Warwick Business School

Multiple version iconThere are 2 versions of this paper

Date Written: December 5, 2008

Abstract

Liquidity hoarding by banks and extreme volatility of the fed funds rate have been widely seen as severely disrupting the interbank market and the broader financial system during the 2007-08 financial crisis. Using a dataset of intraday Federal Reserve bank account balances and Fedwire interbank transactions to estimate all overnight fed funds trades, we show empirical evidence on banks' precautionary hoarding of reserves, reluctance to lend and extreme fed funds rate volatility. We develop a model with credit and liquidity frictions in the interbank market consistent with the empirical results. Banks rationally hold excess reserves intraday and overnight as a precautionary measure to self-insure against liquidity shocks. The intraday fed funds can spike above the discount rate and crash to near zero. Apparent anomalies during the crisis may be explained as the stark but natural outcomes of our general model of the interbank market. The model also provides a unified explanation for previously documented stylized facts and makes new predictions for the interbank market.

Keywords: excess reserves, fed funds market, discount window, large-value payments, limited participation

JEL Classification: G21, G28, E42, E58

Suggested Citation

Ashcraft, Adam B. and McAndrews, James and Skeie, David R., Precautionary Reserves and the Interbank Market (December 5, 2008). Available at SSRN: https://ssrn.com/abstract=1364704 or http://dx.doi.org/10.2139/ssrn.1364704

Adam B. Ashcraft

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045-0001
United States
212-720-1617 (Phone)
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James McAndrews

Wharton Financial Institutions Center ( email )

2306 Steinberg Hall-Dietrich Hall
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Philadelphia, PA 19104
United States
9176090086 (Phone)
19104 (Fax)

David R. Skeie (Contact Author)

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

HOME PAGE: http://www.wbs.ac.uk/about/person/david-skeie

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