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Discussion Paper
Preemptive Runs and the Offshore U.S. Dollar Money Market Funds Industry
In March 2020, U.S. dollar-denominated prime money market funds (MMFs) suffered heavy outflows as concerns about the COVID-19 pandemic increased in the United States and Europe. Investors redeemed their shares en masse not only from funds domiciled in the United States (“domestic”) but also from offshore funds. In this post, we use differences in the regulatory regimes of domestic and offshore funds to identify the impact of the redemption gates and liquidity fees recently introduced as part of MMF industry reforms in both the United States and Europe.
Report
Financial Transaction Taxes and the Informational Efficiency of Financial Markets: A Structural Estimation
We develop a new methodology to estimate the impact of a financial transaction tax (FTT) on financial market outcomes. In our sequential trading model, there are price-elastic noise and informed traders. We estimate the model through maximum likelihood for a sample of sixty New York Stock Exchange (NYSE) stocks in 2017. We quantify the effect of introducing an FTT given the parameter estimates. An FTT increases the proportion of informed trading, improves information aggregation, but lowers trading volume and welfare. For some less-liquid stocks, however, an FTT blocks private information ...
Discussion Paper
Municipal Debt Markets and the COVID-19 Pandemic
In March, with the outbreak of the COVID-19 pandemic in the United States, the market for municipal securities was severely stressed: mutual fund redemptions sparked unprecedented selling of municipal securities, yields increased sharply, and issuance dried up. In this post, we describe the evolution of municipal bond market conditions since the onset of the COVID-19 crisis. We show that conditions in municipal markets have improved significantly, in part a result of the announcement and implementation of several Federal Reserve facilities. Yields have decreased substantially, mutual funds ...
Discussion Paper
Money Market Funds and Systemic Risk
On September 16, 2008, Reserve Primary Fund, a money market fund (MMF) with $65 billion in assets under management, announced that losses in its portfolio had caused the value of shares in the fund to drop from $1.00 to $0.97. The news that an MMF had ?broken the buck? spread panic quickly to other MMFs. In the two days following Reserve?s announcement, investors withdrew approximately $200 billion (10 percent of assets) from so-called ?prime? MMFs, which, like Reserve, mainly invest in privately issued short-term securities. The massive redemptions and resulting strains on MMFs contributed ...
Report
Informational contagion in the laboratory
We study the informational channel of financial contagion in the laboratory. In our experiment, two markets with correlated fundamentals open sequentially. In both markets, subjects receive private information. Subjects in the market opening second also observe the history of trades and prices in the first market. We find that although in both markets private information is only imperfectly aggregated, subjects are able to make correct inferences based on the public information coming from the market that opens first. As a result, we observe financial contagion in the laboratory: Indeed, the ...
Report
The minimum balance at risk: a proposal to mitigate the systemic risks posed by money market funds
This paper introduces a proposal for money market fund (MMF) reform that could mitigate systemic risks arising from these funds by protecting shareholders, such as retail investors, who do not redeem quickly from distressed funds. Our proposal would require that a small fraction of each MMF investor's recent balances, called the "minimum balance at risk" (MBR), be demarcated to absorb losses if the fund is liquidated. Most regular transactions in the fund would be unaffected, but redemptions of the MBR would be delayed for thirty days. A key feature of the proposal is that large redemptions ...
Discussion Paper
Money Market Funds and the New SEC Regulation
On October 14, 2016, amendments to Securities and Exchange Commission (SEC) rule 2a-7, which governs money market mutual funds (MMFs), went into effect. The changes are designed to reduce MMFs? susceptibility to destabilizing runs and contain two principal requirements. First, institutional prime and muni funds?but not retail or government funds?must now compute their net asset values (NAVs) using market-based factors, thereby abandoning the fixed NAV that had been a hallmark of the MMF industry. Second, all prime and muni funds must adopt a system of gates and fees on redemptions, which can ...
Discussion Paper
The Money Market Fund Liquidity Facility
Over the first three weeks of March, as uncertainty surrounding the COVID-19 pandemic increased, prime and municipal (muni) money market funds (MMFs) faced large redemption pressures. Similarly to past episodes of industry dislocation, such as the 2008 financial crisis and the 2011 European bank crisis, outflows from prime and muni MMFs were mirrored by large inflows into government MMFs, which have historically been seen by investors as a safe haven in times of crisis. In this post, we describe a liquidity facility established by the Federal Reserve in response to these outflows.
Discussion Paper
A New Reserves Regime? COVID-19 and the Federal Reserve Balance Sheet
Aggregate reserves declined from nearly $3 trillion in August 2014 to $1.4 trillion in mid-September 2019, as the Federal Reserve normalized its balance sheet. This decline came to a halt in September 2019 when the Federal Reserve responded to turmoil in short-term money markets, with reserves fluctuating around $1.6 trillion in the early months of 2020. Then, in response to the COVID-19 pandemic, the Federal Reserve dramatically expanded its balance sheet, both directly, through outright purchases and repurchase agreements, and indirectly, as a consequence of the facilities to support market ...
Report
Estimating a structural model of herd behavior in financial markets
We develop a new methodology for estimating the importance of herd behavior in financial markets. Specifically, we build a structural model of informational herding that can be estimated with financial transaction data. In the model, rational herding arises because of information-event uncertainty. We estimate the model using 1995 stock market data for Ashland Inc., a company listed on the New York Stock Exchange. Herding occurs often and is particularly pervasive on certain days. In an information-event day, on average, 2 percent (4 percent) of informed traders herd-buy (sell). In 7 percent ...