A Black Swan in the Money Market

2008

377 citations recorded by the source corpus.

At the center of the financial market crisis of 2007-2008 was a highly unusual jump in spreads between the overnight inter-bank lending rate and term London inter-bank offer rates (Libor). Because many private loans are linked to Libor rates, the sharp increase in these spreads raised the cost of borrowing and interfered with monetary policy. The widening spreads became a major focus of the Federal Reserve, which took several actions -- including the introduction of a new term auction facility (TAF) --- to reduce them. This paper documents these developments and, using a no-arbitrage model of the term structure, tests various explanations, including increased risk and greater liquidity demands, while controlling for expectations of future interest rates. We show that increased counterparty risk between banks contributed to the rise in spreads and find no empirical evidence that the TAF has reduced spreads. The results have implications for monetary policy and financial economics.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/a04fd9644e240921ba6196ff4acfd553f7571e8d

Citations in the corpus

• Market response to policy initiatives during the global financial crisis (2012, neutral): “…financial system— spillovers and policy coordination Novel and non-transparent financial instruments Analysis focused on specific policies or countries Taylor and Williams (2009) Panetta et al (2009), Baba and Packer (2009), King (2009) 5 Contribution Broad range of policy initiatives…”
• The Financial Crisis of 2007–2009: Why Did It Happen and What Did We Learn? (2015, positive): “The Taylor and Williams (2009) paper discussed earlier also examines the effect of some of the policy interventions to shed further light on this issue. Taylor and Williams (2009) show that the TAF had little effect on the LIBOR-OIS spread. Moreover, the sharp reduction in the federal funds rate dur”
• Time-varying monetary-policy rules and financial stress: Does financial instability matter for monetary policy? (2011, positive): “On the one hand, the changes in official policy rate may not fully pass through into interbank interest rates, in particular when the perceived counterparty risk is too high and the credit spreads widen (see Taylor and Williams, 2009).”
• How Effective Were the Federal Reserve Emergency Liquidity Facilities? Evidence from the Asset‐Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (2013, neutral): “Along these lines, several recent papers evaluate the impact of these policy interventions using aggregate data (e.g., Christensen, Lopez, and Rudebusch (2009), Stroebel and Taylor (2009), Taylor and Williams (2009), and Wu (2009)).”
• Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk (2009, neutral): “26 for liquidity against a wide set of collateral and committed itself to uphold the full allotment for a considerable amount of time, concerns about aggregate liquidity shortages are greatly reduced (see also Taylor, 2009).”
• Mind the Gap: Disentangling Credit and Liquidity in Risk Spreads (2018, neutral): “…rates are driven by credit, reflecting compensation for heightened default risk – see Afonso, Kovner and Schoar (2011), Filipović and Trolle (2013), Taylor and Williams (2009), Beber, Brandt and Kavajecz (2009), and McAndrews, Sarkar and Wang (2008) – or by poor liquidity (Michaud and Upper…”
• The Term Structure of Interbank Risk (2012, neutral): “These papers include Schwartz (2010), Taylor and Williams (2009), McAndrews, Sarkar, and Wang (2008), Michaud and Upper (2008), and Eisenschmidt and Tapking (2009).”
• Monetary Policy in Exceptional Times (2012, neutral): “7 See Taylor and Williams (2008), McAndrews, et al. (2008), Wu (2008) and Christensen, et al. (2009).”