Liquidity, Information, and the Overnight Rate

38 Pages Posted: 14 Jun 2004  

Christian Ewerhart

University of Zurich - Department of Economics

Nuno Cassola

European Central Bank (ECB)

Steen Ejerskov

European Central Bank (ECB)

Natacha Valla

Banque de France; European Central Bank (ECB)

Date Written: July 2004

Abstract

We model the interbank market for overnight credit with heterogeneous banks and asymmetric information. An unsophisticated bank just trades to compensate its liquidity imbalance, while a sophisticated bank will exploit its private information about the liquidity situation in the market. It is shown that with positive probability, the liquidity effect (Hamilton, 1997) is reversed, i.e., a liquidity drainage from the banking system may generate an overall decrease in the market rate. The phenomenon does not disappear when the number of banks increases. We also show that private information mitigates the effect of an unexpected liquidity shock on the market rate, suggesting a conservative information policy from a central bank perspective.

Keywords: Liquidity effect, asymmetric information, monetary policy implementation

JEL Classification: G14, G21, E52

Suggested Citation

Ewerhart, Christian and Cassola, Nuno and Ejerskov, Steen and Valla, Natacha, Liquidity, Information, and the Overnight Rate (July 2004). ECB Working Paper No. 378; IEER Working Paper No. 186. Available at SSRN: https://ssrn.com/abstract=556070

Christian Ewerhart (Contact Author)

University of Zurich - Department of Economics ( email )

Winterthurerstrasse 30
CH-8006 Zurich
Switzerland

Nuno Cassola

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0044 69 1344 6000 (Fax)

Steen Ejerskov

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Natacha Valla

Banque de France ( email )

31 rue Croix des Petits Champs
75049 Paris Cedex 01
France
+33 1 42922756 (Phone)
+33 1 42926296 (Fax)

HOME PAGE: http://www.iue.it/Personal/Researchers/valla/

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 13440 (Phone)

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