Public Provision of Private Liquidity: Evidence from the Millennium Date Change

50 Pages Posted: 21 Nov 2005  

Suresh M. Sundaresan

Columbia Business School - Finance and Economics

Zhenyu Wang

University of Texas at Austin - Department of Finance

Date Written: September 21, 2004

Abstract

The Millennium Date Change (often referred to as Y2K) was anticipated to be a major liquidity event by many financial and corporate institutions as well as the central banks around the world. The timing of the event was foreseeable and thus satisfies the assumptions in the economic theory on public provision of private liquidity. We apply the theory to understand the liquidity premium in financial markets and the actions of the U.S. central bank in the period surrounding Y2K. We demonstrate that in the presence of this potential aggregate liquidity shock, (1) the cost of private loans and insurance increased significantly, (2) government securities commanded a liquidity premium, and most importantly, (3) the Fed successfully provided liquidity insurance and reduced liquidity premium prior to Y2K by taking various actions and especially by issuing Y2K options. These results are consistent with the predictions of the economic theory. Our analysis links the behavior of on/off-the-run spread to the public provision of private liquidity.

Keywords: Y2K, CDC, liquidity, on-the-run, off-the-run, options

Suggested Citation

Sundaresan, Suresh M. and Wang, Zhenyu, Public Provision of Private Liquidity: Evidence from the Millennium Date Change (September 21, 2004). AFA 2006 Boston Meetings Paper. Available at SSRN: https://ssrn.com/abstract=599085 or http://dx.doi.org/10.2139/ssrn.599085

Suresh M. Sundaresan (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
212-854-4423 (Phone)
212-316-9180 (Fax)

HOME PAGE: http://www0.gsb.columbia.edu/faculty/ssundaresan/

Zhenyu Wang

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-5781 (Phone)

HOME PAGE: http://www.mccombs.utexas.edu/faculty/zhenyu.wang/

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