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Liquidity, Information, and the Overnight Rate


Ewerhart, Christian; Cassola, Nuno; Ejerskov, Steen; Valla, Natacha (2004). Liquidity, Information, and the Overnight Rate. Working paper series / Institute for Empirical Research in Economics No. 186, University of Zurich.

Abstract

We model the interbank market for overnight credit with heterogeneous banks and asymmetric information. An unsophisticated bank justntrades to compensate its liquidity imbalance, while a sophisticated bank willnexploit 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 generatenan 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.

Abstract

We model the interbank market for overnight credit with heterogeneous banks and asymmetric information. An unsophisticated bank justntrades to compensate its liquidity imbalance, while a sophisticated bank willnexploit 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 generatenan 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.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Working Paper Series > Institute for Empirical Research in Economics (former)
Dewey Decimal Classification:330 Economics
Language:English
Date:May 2004
Deposited On:29 Nov 2011 22:32
Last Modified:07 Dec 2017 10:09
Series Name:Working paper series / Institute for Empirical Research in Economics
ISSN:1424-0459
Official URL:http://www.econ.uzh.ch/wp.html

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