The impact of the Term Auction Facility on the liquidity risk premium and unsecured interbank spreads

Olav Syrstad
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Olav Syrstad: Norges Bank, http://www.norges-bank.no/

No 2014/07, Working Paper from Norges Bank

Abstract: This paper investigates the effectiveness of the Federal Reserve's Term Auction Facility (TAF) in alleviating the liquidity shortage in USD and reducing the spread between the 3-month Libor rate and the expected policy rate. I construct a proxy for the 3-month liquidity risk premium based on data from the FX forward market which enables me to (i) decompose the Libor spread into a liquidity premium and a credit premium, and (ii) test the effectiveness of the TAF in reducing the liquidity premium in money market spreads. I find that long-term (84-day) TAF auctions were effective in reducing the 3-month liquidity premium. Furthermore, a reduction in the liquidity premium led to a fall in the 3-month Libor spread in USD. Credit risk, however, seems to have been a rather modest factor in explaining the increase in the Libor spread during the financial crisis.

Keywords: Term Auction Facility; liquidity premium; credit premium; Libor-OIS spread (search for similar items in EconPapers)
JEL-codes: E41 E43 E51 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2014-05-15
New Economics Papers: this item is included in nep-mac and nep-mon
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:bno:worpap:2014_07

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