Why Is the Effective Fed Funds Rate Below the Theoretical Floor?

Journal of Applied Finance, Vol. 24, No. 2, 2014, pgs. 61-69

9 Pages Posted: 29 Oct 2015  

Mark D. Griffiths

Miami University of Ohio - Department of Finance

Kyle D. Allen

Louisiana Tech University

Scott E. Hein

Texas Tech University - Area of Finance

Drew B. Winters

Texas Tech University

Date Written: 2014

Abstract

Starting on December 18, 2008 the Federal Reserve began paying 25 basis points (bps) on the reserves of depository institutions. Theory argues that the rate paid on reserves establishes a floor for the federal funds market. Nonetheless, the effective federal funds rate has stayed well below this theoretical floor value, on occasion by as much as 18 bps. This suggests the possibility of an arbitrage opportunity. This paper offers an explanation of this ongoing puzzle by explaining the limits to arbitrage and arguing that the anomaly persists, in part, due to costs associated with the Federal Deposit Insurance Corporation (FDIC) assessment on the liabilities of depository institutions and capital charges. The size of the difference is also found to increase with the Federal Reserve’s quantitative easing programs.

Suggested Citation

Griffiths, Mark D. and Allen, Kyle D. and Hein, Scott E. and Winters, Drew B., Why Is the Effective Fed Funds Rate Below the Theoretical Floor? (2014). Journal of Applied Finance, Vol. 24, No. 2, 2014, pgs. 61-69. Available at SSRN: https://ssrn.com/abstract=2681301

Mark D. Griffiths (Contact Author)

Miami University of Ohio - Department of Finance ( email )

Oxford, OH 45056
United States

Kyle D. Allen

Louisiana Tech University ( email )

P.O. Box 3178
Ruston, LA 71272
United States
4358648805 (Phone)

Scott E. Hein

Texas Tech University - Area of Finance ( email )

PO Box 42101
Lubbock, TX TX 79409
United States
806-8342-3433 (Phone)
806-742-2099 (Fax)

HOME PAGE: http://www.depts.ttu.edu/rawlsbusiness/people/faculty/finance/scott-e-hein/index.php

Drew B. Winters

Texas Tech University ( email )

Finance Department
Rawls College of Business
Lubbock, TX 79409
United States
806-742-3350 (Phone)
806-742-3197 (Fax)

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