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

Federal Reserve Bank of New York

David R. Skeie

Texas A&M University - Mays Business School - Department of Finance

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)
212-720-8363 (Fax)

James McAndrews

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-5063 (Phone)
212-720-8353 (Fax)

David R. Skeie (Contact Author)

Texas A&M University - Mays Business School - Department of Finance ( email )

360E Wehner
College Station, TX 77843-4218
United States
949-845-1224 (Phone)
979-845-3884 (Fax)

HOME PAGE: http://mays.tamu.edu/directory/drs/

Register to save articles to
your library

Register

Paper statistics

Downloads
126
Abstract Views
1,477
rank
115,209
PlumX Metrics