Interbank Markets under Currency Boards Marius Jurgilas University of Connecticut August 2007 Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 1 / 29
Outline Introduction 1 Institutional structure of interbank markets under currency boards 2 Liquidity effect under a currency board 3 Motivation Data and Methodology Results Reserve management under a currency board 4 Motivation Model Results Monetary policy under a currency board 5 Motivation Model Results Conclusion 6 Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 2 / 29
Introduction Definitions Interbank market Market for unsecured short period (overnight) loans or “reserves market”. Bank reserve management Liquidity for day-to-day activities Minimum reserve requirement Currency board Specific type of a fixed exchange rate regime. Fully backed liabilities of the central bank Exchange of funds to/from the base currency Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 3 / 29
Introduction Definitions Interbank market Market for unsecured short period (overnight) loans or “reserves market”. Bank reserve management Liquidity for day-to-day activities Minimum reserve requirement Currency board Specific type of a fixed exchange rate regime. Fully backed liabilities of the central bank Exchange of funds to/from the base currency Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 3 / 29
Institutional structure of interbank markets under currency boards First essay: Institutional structure of interbank markets under currency boards No activist monetary policy Convergence of interest rates Required reserves Government’s bank Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 4 / 29
Institutional structure of interbank markets under currency boards Bulgaria Figure: Interbank interest rates in Bulgaria Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 5 / 29
Institutional structure of interbank markets under currency boards Lithuania Figure: Interbank interest rates in Lithuania Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 6 / 29
Liquidity effect under a currency board Motivation Second essay: Liquidity effect under a currency board Motivation: Ongoing debate on the existence of the liquidity effect in the literature (Hamilton (1996), Thornton (2001), Carpenter and Demiralp (2006), Thornton (2006)) Questions: 1 Do exogenous changes in aggregate liquidity affect interest rate: is there a “liquidity effect”? 2 Should we observe constant interest rates in case of efficient interbank market? Why currency board countries? Central banks do not intervene in reserves market Phenomenon of decreasing interest rates towards the end of the reserve holding period Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 7 / 29
Liquidity effect under a currency board Motivation Second essay: Liquidity effect under a currency board Motivation: Ongoing debate on the existence of the liquidity effect in the literature (Hamilton (1996), Thornton (2001), Carpenter and Demiralp (2006), Thornton (2006)) Questions: 1 Do exogenous changes in aggregate liquidity affect interest rate: is there a “liquidity effect”? 2 Should we observe constant interest rates in case of efficient interbank market? Why currency board countries? Central banks do not intervene in reserves market Phenomenon of decreasing interest rates towards the end of the reserve holding period Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 7 / 29
Liquidity effect under a currency board Motivation Second essay: Liquidity effect under a currency board Motivation: Ongoing debate on the existence of the liquidity effect in the literature (Hamilton (1996), Thornton (2001), Carpenter and Demiralp (2006), Thornton (2006)) Questions: 1 Do exogenous changes in aggregate liquidity affect interest rate: is there a “liquidity effect”? 2 Should we observe constant interest rates in case of efficient interbank market? Why currency board countries? Central banks do not intervene in reserves market Phenomenon of decreasing interest rates towards the end of the reserve holding period Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 7 / 29
Liquidity effect under a currency board Data and Methodology Data and Methodology Aggregate interbank market data for Bulgaria and Lithuania Lithuania: 2002:02-2005:12 (990 daily observations) Bulgaria: 2002:01-2006:04 (1041 daily observations) Estimating EGARCH( γ, q ) model of the following form: r t = µ t + h t ǫ t r t − 1 + b ′ X t where µ t = p N [0 , 1] + (1 − p ) N [0 , σ 2 ] ∼ ǫ t q and ln h t = λ ′ V t d j 1 (ln h t − 1 − λ ′ V t − 1 ) + � + j =1 p � d i 3 ( | ǫ t − 1 | 2 ǫ t − 1 � + + − π ) d i 2 � � h t − 1 h t − 1 i =1 Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 8 / 29
Liquidity effect under a currency board Data and Methodology Data and Methodology Aggregate interbank market data for Bulgaria and Lithuania Lithuania: 2002:02-2005:12 (990 daily observations) Bulgaria: 2002:01-2006:04 (1041 daily observations) Estimating EGARCH( γ, q ) model of the following form: r t = µ t + h t ǫ t r t − 1 + b ′ X t where µ t = p N [0 , 1] + (1 − p ) N [0 , σ 2 ] ∼ ǫ t q and ln h t = λ ′ V t d j 1 (ln h t − 1 − λ ′ V t − 1 ) + � + j =1 p � d i 3 ( | ǫ t − 1 | 2 ǫ t − 1 � + + − π ) d i 2 � � h t − 1 h t − 1 i =1 Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 8 / 29
Liquidity effect under a currency board Results Empirical Results Do exogenous changes in aggregate liquidity affect interest rate: is there a “liquidity effect”? No liquidity effect Do we observe constant interest rates? Decreasing interest rates Other results: Interest rates increase with the aggregate reserve deficiency Higher aggregate deficiency is associated with falling interest rates towards the end of the reserve holding period Variability of interest rates decreases with a decrease in the foreign exchange fee Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 9 / 29
Liquidity effect under a currency board Results Empirical Results Do exogenous changes in aggregate liquidity affect interest rate: is there a “liquidity effect”? No liquidity effect Do we observe constant interest rates? Decreasing interest rates Other results: Interest rates increase with the aggregate reserve deficiency Higher aggregate deficiency is associated with falling interest rates towards the end of the reserve holding period Variability of interest rates decreases with a decrease in the foreign exchange fee Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 9 / 29
Liquidity effect under a currency board Results Empirical Results Do exogenous changes in aggregate liquidity affect interest rate: is there a “liquidity effect”? No liquidity effect Do we observe constant interest rates? Decreasing interest rates Other results: Interest rates increase with the aggregate reserve deficiency Higher aggregate deficiency is associated with falling interest rates towards the end of the reserve holding period Variability of interest rates decreases with a decrease in the foreign exchange fee Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 9 / 29
Liquidity effect under a currency board Results Empirical Results Do exogenous changes in aggregate liquidity affect interest rate: is there a “liquidity effect”? No liquidity effect Do we observe constant interest rates? Decreasing interest rates Other results: Interest rates increase with the aggregate reserve deficiency Higher aggregate deficiency is associated with falling interest rates towards the end of the reserve holding period Variability of interest rates decreases with a decrease in the foreign exchange fee Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 9 / 29
Reserve management under a currency board Motivation Third essay: Reserve Management under a currency board Provide a theoretical explanation for decreasing interest rates Gaspar et al. (2004) and Quir´ os and Mendiz´ abal (2006): interest rates should be increasing. This paper: there are circumstances under which interest rates are decreasing. Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 10 / 29
Reserve management under a currency board Motivation Third essay: Reserve Management under a currency board Provide a theoretical explanation for decreasing interest rates Gaspar et al. (2004) and Quir´ os and Mendiz´ abal (2006): interest rates should be increasing. This paper: there are circumstances under which interest rates are decreasing. Marius Jurgilas (University of Connecticut) Interbank Markets under Currency Boards August 2007 10 / 29
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