Research Discussion Papers, Bank of Finland
No 24/2002:
Variable rate liquidity tenders
Tuomas Välimäki ()
Abstract: This paper constructs an equilibrium model for the
short-term money market, when the central bank provides liquidity via
variable rate tenders. The relation between market rate of interest and
liquidity is derived from a single bank’s profit maximisation problem in
the interbank market, and the CB determines its liquidity provision by
minimising a quadratic loss function that contains both deviations of
expected market rate from CB target rate and differences between liquidity
supply and target liquidity. We model equilibrium bid behaviour in the
tenders and explain the underbidding phenomenon resulting from the minimum
bid rate. We also show that, when maturities of consecutive operations
overlap, the expected market interest rate will rise above the CB’s target
whenever a target rate change (hike or cut) is expected to occur in the
same reserve maintenance period. Finally, we review the data from the ECB
variable rate tenders and find that the ECB has been fairly liquidity
oriented in its allotment decisions.
Keywords: money market tenders; liquidity policy; bidding; central bank operational framework; (follow links to similar papers)
JEL-Codes: E43; E58; G21; (follow links to similar papers)
50 pages, September 30, 2002
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