Research Discussion Papers, Bank of Finland
No 21/2013:
Central bank liquidity auction mechanism design and the interbank market
Kimmo Ollikka ()
and Janne Tukiainen ()
Abstract: We study whether the mechanism design in the central bank
liquidity auctions matters for the interbank money market interest rate
levels and volatility. Furthermore, we compare different mechanisms to sell
liquidity in terms of revenue, efficiency and auction stage interest rate
levels and volatility. Most importantly, we ask which mechanism is the best
at implementing the target policy interest rates to the interbank market
and what are the trade-offs involved. We construct a relatively general
model of strategic bidding with interdependent valuations, and combine it
with a stylized model of the interbank market. The novel feature of the
model is that the expectations of the interbank market outcomes determine
the valuations in the liquidity auctions. The model captures the relevant
features of how the European Central Bank sells liquidity. We use
simulations to compare discriminatory price, uniform price and Vickrey
auctions to a posted price mechanism with full allotment. In order to
analyze interactions between the primary and the secondary market under
four different mechanisms, we need to make a lot of assumptions and
simpli cations. Given this caveat, we find that posted prices with full
allotment is clearly the superior alternative in terms of implementing the
policy interest rate to the interbank markets. This comes at the cost of
less revenue compared to the revenue maximizing discriminatory price
auction, but surprisingly, will not result in efficiency losses compared
even to the Vickrey auction.
Keywords: ECB liquidity auctions; interbank markets; mechanism design; multi-unit auctions; monetary policy; posted-prices; (follow links to similar papers)
JEL-Codes: C63; C72; D02; D44; D47; D53; E43; E44; E52; E58; G21; (follow links to similar papers)
47 pages, September 17, 2013
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