The Effect of the Term Auction Facility on the London Interbank Offered Rate

54 Pages Posted: 19 Sep 2015 Last revised: 5 Jan 2017

See all articles by James McAndrews

James McAndrews

Wharton Financial Institutions Center

Asani Sarkar

Federal Reserve Bank of New York

Zhenyu Wang

Indiana University, Kelley School of Business

Date Written: January 2017

Abstract

The Term Auction Facility (TAF), the first auction-based liquidity initiative by the Federal Reserve during the global financial crisis, was aimed at improving conditions in the dollar money market and bringing down the significantly elevated London interbank offered rate (Libor). The effectiveness of this innovative policy tool is crucial for understanding the role of the central bank in financial stability, but academic studies disagree on the empirical evidence of the TAF effect on Libor. We show that the disagreement arises from misspecifications of econometric models. Regressions using the daily level of the Libor-OIS spread as the dependent variable miss either the permanent or temporary TAF effect, depending on whether the dummy variable indicates the events of the TAF or the regimes before and after a TAF event. Those regressions also suffer from the unit-root problem and produce unreliable test statistics. By contrast, regressions using the daily change in the Libor-OIS spread are robust to the persistence of the TAF effect and the unit-root problem, consistently producing reliable evidence that the downward shifts of the Libor-OIS spread were associated with the TAF. The evidence indicates the efficacy of the TAF in helping the interbank market to relieve liquidity strains.

Keywords: Libor, liquidity, money markets, Term Auction Facility

JEL Classification: G1, G12, G18

Suggested Citation

McAndrews, James and Sarkar, Asani and Wang, Zhenyu, The Effect of the Term Auction Facility on the London Interbank Offered Rate (January 2017). FRB of New York Staff Report No. 335, Available at SSRN: https://ssrn.com/abstract=2662108 or http://dx.doi.org/10.2139/ssrn.2662108

James McAndrews

Wharton Financial Institutions Center ( email )

2306 Steinberg Hall-Dietrich Hall
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19104 (Fax)

Asani Sarkar

Federal Reserve Bank of New York ( email )

Research Department
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New York, NY 10045
United States
212-720-8943 (Phone)
212-720-1582 (Fax)

HOME PAGE: http://www.newyorkfed.org/research/economists/sarkar/pub.html

Zhenyu Wang (Contact Author)

Indiana University, Kelley School of Business ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

HOME PAGE: http://www.kelley.iu.edu/Finance/Faculty/page12594.cfm?ID=37555

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