The 2007 Subprime Market Crisis Through the Lens of European Central Bank Auctions for Short-Term Funds

60 Pages Posted: 21 Jul 2009 Last revised: 10 Aug 2009

See all articles by Nuno Cassola

Nuno Cassola

University of Milan Bicocca - CefES; University of Lisbon - CEMAPRE

Ali Hortacsu

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Jakub Kastl

Princeton University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2009

Abstract

In this paper we study European banks' demand for short-term funds (liquidity) during the summer 2007 subprime market crisis. We use bidding data from the European Central Bank's auctions for one-week loans, their main channel of monetary policy implementation. Through a model of bidding, we show that banks' behavior reflects their cost of obtaining short-term funds elsewhere (i.e., in the interbank market) as well as a strategic response to other bidders. We find considerable heterogeneity across banks in their willingness to pay for short-term funds supplied in these auctions. Accounting for the strategic component is important: while a naive interpretation of the raw bidding data may suggest that virtually all banks suffered a dramatic increase in the cost of obtaining funds in the interbank market, we find that for about one third of the banks, the change in bidding behavior was simply a strategic response. Using a complementary data set, we also find that banks' pre-turmoil liquidity costs, as estimated by our model, are predictive of their post-turmoil liquidity costs, and that there is considerable heterogeneity in these costs with respect to the country-of-origin. Finally, among the publicly traded banks, the willingness to pay for short-term funds in the second half of 2007 are predictive of stock prices in late 2008.

Suggested Citation

Cassola, Nuno and Hortacsu, Ali and Kastl, Jakub, The 2007 Subprime Market Crisis Through the Lens of European Central Bank Auctions for Short-Term Funds (July 2009). NBER Working Paper No. w15158, Available at SSRN: https://ssrn.com/abstract=1435596

Nuno Cassola

University of Milan Bicocca - CefES ( email )

Milan
Italy

University of Lisbon - CEMAPRE ( email )

Lisbon
Portugal

Ali Hortacsu (Contact Author)

University of Chicago - Department of Economics ( email )

1126 East 59th Street
Chicago, IL 60637
United States
773-702-5841 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jakub Kastl

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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