The Euro Overnight Interbank Market and ECB's Liquidity Management Policy During Tranquil and Turbulent Times

61 Pages Posted: 5 Oct 2010

See all articles by Nuno Cassola

Nuno Cassola

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

Michael Huetl

affiliation not provided to SSRN

Date Written: September 17, 2010


We analyze the impact of the recent financial market crisis on the Euro Overnight Index Average (EONIA) and interbank market trading and assess the effectiveness of the ECB liquidity policy between 07/2007 - 08/2008. We extend the model of [QM06] by (i) incorporating the microstructure of the EONIA market including the ECB fine-tuning operation on the last day of the maintenance period (MP) and banks’ daily excess liquidity, (ii) giving insight into banks’ trading behavior characterized by an endogenous regime-switch and suggesting an efficient procedure to simulate the entire MP, and (iii) proposing a model for market distortion due to lending constraints which lead to a bid-ask spread for the EONIA rate. The model is calibrated by simulation fitting daily EONIA rates and aggregate liquidity measures observed between March 2004 and September 2008. Besides lending constraints we consider market segmentation and aggregate liquidity shocks as possible market distortions in the crisis period. For a calibration cross-check and for estimating the timing of the endogenous regime-switch we use panel data covering liquidity data of 82 Euro Area commercial banks for the period 03/2003 - 07/2007. With the calibrated model the ECB policy of liquidity frontloading is evaluated and compared with a reserve band system policy similar to the Bank of England’s framework. We find that liquidity frontloading is a small scale central bank intervention which is capable of stabilizing interest rates in both frictionless and distorted markets. Simulations suggest that without frontloading the EONIA would have been, on average, 23 basis points above the policy rate (target); with frontloading, the overnight rate is, on average, on target.

Keywords: liquidity management, open market operations, simulation, microstructure

JEL Classification: E44, E52, G21

Suggested Citation

Cassola, Nuno and H., Michael, The Euro Overnight Interbank Market and ECB's Liquidity Management Policy During Tranquil and Turbulent Times (September 17, 2010). ECB Working Paper No. 1247, Available at SSRN:

Nuno Cassola (Contact Author)

University of Milan Bicocca - CefES ( email )


University of Lisbon - CEMAPRE ( email )


Michael H.

affiliation not provided to SSRN ( email )

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
PlumX Metrics