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Working Paper
Modeling Money Market Spreads: What Do We Learn about Refinancing Risk?
We quantify the effect of refinancing risk on euro area money market spreads, a major factor driving spreads during the financing crisis. With the advent of the crisis, market participants' perception of their ability to refinance over a given period of time changed radically. As a result, borrowers preferred to obtain funding for longer tenors and lenders were willing to provide funding for shorter tenors. This discrepancy resulted in a need to refinance more frequently in order to borrow over a given horizon, thus increasing refinancing risk. We measure refinancing risk by quantifying the ...
Working Paper
Interbank Connections, Contagion and Bank Distress in the Great Depression
Liquidity shocks transmitted through interbank connections contributed to bank distress during the Great Depression. New data on interbank connections reveal that banks were much more likely to close when their correspondents closed. Further, after the Federal Reserve was established, banks? management of cash and capital buffers was less responsive to network risk, suggesting that banks expected the Fed to reduce network risk. Because the Fed?s presence removed the incentives for the most systemically important banks to maintain capital and cash buffers that had protected against liquidity ...
Working Paper
Central Clearing and Systemic Liquidity Risk
By stepping between bilateral counterparties, a central counterparty (CCP) transforms credit exposure. CCPs generally improve financial stability. Nevertheless, large CCPs are by nature concentrated and interconnected with major global banks. Moreover, although they mitigate credit risk, CCPs create liquidity risks, because they rely on participants to provide cash. Such requirements increase with both market volatility and default; consequently, CCP liquidity needs are inherently procyclical. This procyclicality makes it more challenging to assess CCP resilience in the rare event that one or ...
Working Paper
Central Clearing and Systemic Liquidity Risk
By stepping between bilateral counterparties, a central counterparty (CCP) transforms credit exposure. CCPs generally improve financial stability. Nevertheless, large CCPs are by nature concentrated and interconnected with major global banks. Moreover, although they mitigate credit risk, CCPs create liquidity risks, because they rely on participants to provide cash. Such requirements increase with both market volatility and default; consequently, CCP liquidity needs are inherently procyclical. This procyclicality makes it more challenging to assess CCP resilience in the rare event that one or ...
Discussion Paper
Internal Liquidity’s Value in a Financial Crisis
A classic question for U.S. financial firms is whether to organize themselves as entities that are affiliated with a bank-holding company (BHC). This affiliation brings benefits, such as access to liquidity from other affiliated entities, as well as costs, particularly a larger regulatory burden. This post highlights the results from a recent Staff Report that sheds light on this tradeoff. This work uses confidential data on the population of broker-dealers to study the benefits of being affiliated with a BHC, with a focus on the global financial crisis (GFC). The analysis reveals that ...
Discussion Paper
Has Liquidity Risk in the Treasury and Equity Markets Increased?
Market participants have argued that market liquidity has deteriorated since the financial crisis. However, inspection of common metrics such as bid-ask spreads, market depth, and price impact do not show pronounced reductions in liquidity compared with precrisis levels. In this post, we argue that recent changes in liquidity conditions may best be described in terms of heightened liquidity risk, as opposed to general declines in liquidity levels. We propose a measure that shows liquidity risk has risen in equity and Treasury markets and discuss some factors behind the increase.
Working Paper
Inflation Expectations and Risk Premia in Emerging Bond Markets: Evidence from Mexico
To study inflation expectations and associated risk premia in emerging bond markets, thispaper provides estimates for Mexico based on an arbitrage-free dynamic term structuremodel of nominal and real bond prices that accounts for their liquidity risk. In addition todocumenting the existence of large and time-varying liquidity premia in nominal and realbond prices that are only weakly correlated, the results indicate that long-term inflationexpectations in Mexico are well anchored close to the inflation target of the Bank ofMexico. Furthermore, Mexican inflation risk premia are larger and more ...
Discussion Paper
Banking System Vulnerability: 2024 Update
After a period of relative stability, a series of bank failures in 2023 renewed questions about the fragility of the banking system. As in previous years, we provide in this post an update of four analytical models aimed at capturing different aspects of the vulnerability of the U.S. banking system using data through 2024:Q2 and discuss how these measures have changed since last year.
Report
Inflation Expectations and Risk Premia in Emerging Bond Markets: Evidence from Mexico
To study inflation expectations and associated risk premia in emerging bond markets, this paper provides estimates for Mexico based on an arbitrage-free dynamic term structure model of nominal and real bond prices that accounts for their liquidity risk. In addition to documenting the existence of large and time-varying liquidity premia in nominal and real bond prices that are only weakly correlated, the results indicate that long-term inflation expectations in Mexico are well anchored close to the inflation target of the Bank of Mexico. Furthermore, Mexican inflation risk premia are larger ...
Working Paper
Bond Flows and Liquidity: Do Foreigners Matter?
In their search for yield in the current low interest rate environment, many investors have turned to sovereign debt in emerging economies, which has raised concerns about risks to financial stability from these capital flows. To assess this risk, we study the effects of changes in the foreign-held share of Mexican sovereign bonds on their liquidity premiums. We find that recent increases in foreign holdings of these securities have played a significant role in driving up their liquidity premiums. Provided the higher compensation for bearing liquidity risk is commensurate with the chance of a ...