Precautionary Reserves and the Interbank Market

2011/09/23 by ADAM ASHCRAFT, Adam B. Ashcraft, JAMES MCANDREWS +3 · 2 citations
Economics, Econometrics and Finance · #Banking stability, regulation, efficiency #Financial Markets and Investment Strategies #Global Financial Crisis and Policies

paper · doi:10.1111/j.1538-4616.2011.00438.x

Abstract

Extreme disruptions in the interbank market severely hampered the broader financial system during the 2007–08 financial crisis. We use Fedwire data to estimate fed funds trades and track banks’ intraday balances. We show empirical evidence of banks’ precautionary holding of reserves and reluctance to lend linked to documented extreme fed funds rate volatility, including the fed funds rate spiking above the discount rate and crashing to zero. We develop a model of constrained banks that makes new predictions and provides a unified explanation for the stark anomalies during the crisis, our empirical findings, and previous stylized facts from normal times.

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