Abstract
We provide a simple model, able to explain why the overnight (ON) rate follows a downward intraday pattern, implicitly creating a positive intraday interest rate. While this normally reflects only some frictions, a liquidity crisis introduces a new component: the chance of an upward jump of the ON rate, which must be compensated by an intraday decline of the ON rate. By analyzing real time data for the e-MID interbank market, we show that the intraday rate has increased from a negligible level to a significant one after the start of the liquidity crisis in August 2007, and even more so since September 2008. The intraday rate is affected by the likelihood of a dry-up of the ON market, proxied by the 3M Euribor—Eonia swap spread. This evidence supports our model and it shows that a liquidity crisis impairs the ability of central banks to curb the market price of intraday liquidity, even by providing free daylight overdrafts. Such results have implications for the efficiency of the money market and of payment systems, as well as for the operational framework of central banks.
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Notes
We are indebted to William Roberds for suggesting this approach to us.
Those frictions are discussed in more detail in Baglioni and Monticini (2008).
Only on settlement days (i.e. at the end of the maintenance period of the reserve requirement) the ON rate may be expected to exhibit large deviations from the target level, due to the need of meeting the reserve requirement without the flexibility allowed by the averaging facility; this is the reason why those days will be excluded from the empirical analysis below.
Note that this assumption is not necessary for our results. All we need is that \(E(R_{2}\left\vert s=1\right) >E(R_{2}\left\vert s=0\right) \). The extension of the model to this more general case is straightforward. We stick to the more restrictive version, as we believe it to be more realistic (except when the ON rate deviates from the policy rate for a substantial time span).
It is worth noting the substantial difference between our result and that obtained by Angelini (2000). In his approach, risk averse banks shift their interbank trades to the morning to offset a high intraday volatility of the ON interest rate; both lenders and borrowers share the same interest, namely to cover from interest rate risk. This typically happens in settlement days. Bank risk aversion is not necessary in our approach.
The correlation coefficient (computed with daily data) between the two interest rates has been 0.95 in our sample period.
We have tested the null hypothesis of equal mean between the first and second sub-samples, and between the second and third ones. In both cases, the null hypothesis is rejected by the parametric Welch two sample t-test and by the non-parametric Wilcoxon rank sum test at the 1% level.
They are provided by the European Banking Federation. See http://www.euribor.org/ for detailed information and for daily data.
The standard errors have been obtained by heteroskedasticity and autocorrelation consistent (HAC) covariance matrix estimators with Bartlett kernel (see Andrews and Monahan 1992). We have also run a regression using the Cochrane–Orcutt approach and standard errors based on the wild bootstrap (see Davidson et al. 2007): the results, which are available upon request, are very similar.
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We are grateful to an anonymous referee and to the Editor for their very useful comments on a previous version of this paper.
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Baglioni, A., Monticini, A. Why Does the Interest Rate Decline Over the Day? Evidence from the Liquidity Crisis. J Financ Serv Res 44, 175–186 (2013). https://doi.org/10.1007/s10693-012-0139-x
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DOI: https://doi.org/10.1007/s10693-012-0139-x