Interest on Reserves and Arbitrage in Post-Crisis Money Markets

Thomas Keating and Marco Macchiavelli

No 2017-124, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: Currently, Eurodollars and fed funds markets combined trade about $220 billion in funds daily, the vast majority of which with overnight tenor. In this paper, we document several features of these wholesale unsecured dollar funding markets. Using daily confidential data on wholesale unsecured borrowing and reserve balances, we show that foreign banks, which make up most of the trading volumes in these markets, keep around 99% of each additional Eurodollar and 80% of each fed fund borrowed as reserve balances. With these risk-free trades, banks earn the spread between interest on reserves and the borrowing rate. Relative to foreign banks, large domestic institutions borrow less often, but when they do, they keep around 99% of each additional Eurodollar or fed fund raised as reserves. Small domestic banks do not display any correlation between net borrowing and their reserves accumulation. We also discuss how regulatory costs affect trading patterns and interest rate differentials in wholesale dollar funding markets.

Keywords: Arbitrage; Eurodollars; Fed funds; Interest on reserves; Monetary policy (search for similar items in EconPapers)
JEL-codes: E43 E52 G21 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2017-12
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2017-124

DOI: 10.17016/FEDS.2017.124

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