ECB Money Market Workshop Discussion Strains on money market makers and money market tensions by Fecht, Reitz and Weber
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1 Dr. Directorate General Market Operations Money Market & Liquidity *Disclaimer: Any views expressed are only those of the author and do not necessarily represent the views of the ECB or the Eurosystem. ECB Money Market Workshop Discussion Strains on money market makers and money market tensions by Fecht, Reitz and Weber Frankfurt am Main, 20 October 2014
2 Rubric Summary Liquidity funding risk impacts money market pricing Data money market order book one German market maker for euro area money market (EURIBOR and EUREPO panel member) between 2007 and 2008 Econometric modelling of pricing equation Results: liquidity funding risk leads to 1. liquidity hoarding 2. increasing term premium 3. drying up of market liquidity (larger bid-ask spread) Discussion of Fecht, Reitz and Weber (2014) 2
3 Rubric Summary Valuable contribution to understanding money markets Contribution to theoretical model evidence Funding constraints impact market liquidity with second round effects Gromb & Vayanos (2002 JFE) and Brunnermeier & Pedersen (2009 RFS) Policy implications Regulation contributing to market stabilisation, e.g. liquidity coverage ratio Importance of central bank liquidity provision in case of liquidity tightening in money markets Discussion of Fecht, Reitz and Weber (2014) 3
4 Rubric Outline Overview 1 Summary 2 Comments on data 3 Comments on methodology 4 Further suggestions Discussion of Fecht, Reitz and Weber (2014) 4
5 Rubric Outline Overview 1 Summary 2 Comments on data 3 Comments on methodology 4 Further suggestions Discussion of Fecht, Reitz and Weber (2014) 5
6 Rubric Comments on data Market scope: Today secured segment more important Source: ECB Money Market Survey Discussion of Fecht, Reitz and Weber (2014) 6
7 Rubric Comments on data Market microstructure: only good risks in unsecured segment Liquidity risk causes higher rating standards Closing of credit lines for risky counterparties Selection bias Possible solutions Use stable sample Selection model approach Counterparty fixed-effect Period Tranquil period Jan 2007 Aug 2007 Subprime crisis Aug 2007 Sep 2008 Lehman collapse Sep 2009 Dec 2008 Borrower rating for money market loans A AA AAA Source: Fecht, Reitz, Weber (2014) Discussion of Fecht, Reitz and Weber (2014) 7
8 Rubric Outline Overview 1 Summary 2 Comments on data 3 Comments on methodology 4 Further suggestions Discussion of Fecht, Reitz and Weber (2014) 8
9 Rubric Comments on methodology Unsecured rates, market liquidity and excess liquidity Source: ECB Monthly Bulletin Jan 2014, p. 79 Note: R-squared statistics, 60-day rolling regression. Source: EMMI, ECB, ECB Staff. Discussion of Fecht, Reitz and Weber (2014) 9
10 Rubric Comments on methodology Using EUREPO as a benchmark rate To capture general changes in the money market rates for instance due to monetary policy Policy rates Deposit facility rate Main refinancing operation rate Market maker is panel member of EUREPO and EURIBOR Multicollinearity issue remains for EUREPO as well as EURIBOR Further issues with EUREPO Analyze market wide credit spread Using GC pooling rates or other repo rates Alternative EONIA-OIS Estimating the money market curve Paper uses next lower available maturity and T/N for overnight loans Creates upward bias in spread r j,t r EUREPO,t-1 for liquidity funding risk Discussion of Fecht, Reitz and Weber (2014) 10
11 Rubric Comments on methodology Identification of fixed-effects for trade level data Panel estimation approach y jt = a j + x jt b + u jt Fixed-effects estimator based on trade (t) / counterparty (j) trade (t) / trader (j) Trades observed on minute level Data cleaning: trade in same minute is changed to two logical seconds Challenge for identification strategy: t{j1} t{j2) for all j What is the right level of aggregation: minutes, hours? Discussion of Fecht, Reitz and Weber (2014) 11
12 Rubric Outline Overview 1 Summary 2 Comments on data 3 Comments on methodology 4 Further suggestions Discussion of Fecht, Reitz and Weber (2014) 12
13 Rubric Further suggestions What is the difference between liquidity funding sources Price setting German Market maker is price setter Profit maximization Cost of liquidity funding and liquidity funding risk Internal Market liquidity funding (control variable NMMF) Funding via the central bank Interaction between liquidity funding sources Is liquidity funding from the central bank a perfect substitute to market or internal liquidity funding? Institutional set up between trading and treasury? Discussion of Fecht, Reitz and Weber (2014) 13
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