In Search of a Risk-Free Asset: Search Costs and Sticky Deposit Rates

Abstract

I examine the role of costly consumer search for the pricing of insured deposits, which is characterized by a large dispersion of offer rates, negative spreads over Treasuries, and upward rigid adjustments following increases in the federal funds rate. Estimates of a model of costly search reveal a large fraction of high-search-cost and a small declining fraction of low-search-cost depositors. The large fraction of high-search-cost depositors, composed mostly of elderly and less financially sophisticated households, grants banks monopoly power and allows for the low interest rate pass-through. The predictions of the estimated model are consistent with responses in the Survey of Consumer Finances to questions related to financial sophistication, search for investment return, and deposit allocations across multiple bank accounts.

Keywords: Deposit rates, Search Costs, Rate rigidity, Rate dispersion, Interest rate pass-through, Coefficient of intertemporal elasticity of substitution, Bank-affiliated money market mutual funds, Limited deposit insurance

JEL Classification: D83, D91, G12, G21