City Research Online

Abstract

This thesis consists of a series of three papers on risk management in banking industry and the liquidity insurance function performed by interbank markets. It is widely agreed that banks cooperatively use the interbank money market to compensate for expected and unexpected short-term liquidity shocks. Yet, we do not have a complete and detailed picture of its behaviour and how it can be connected to the conduction of monetary policy. We link banks’ strategic behaviour to the monetary policy transmission mechanism, and explore the impact of interbank market microstructure on the monetary policy transmission mechanism. We extend mainstream literature on banks liquidity risk management developing a model of the interbank market in which banks trade at a range of maturities rather than simply overnight. The rational expectations solution to the model implies that maximizing profit banks impose a smoothing effect on interbank market interest rates. Using a unique dataset frequency data set of trade flows and interest rates for the Portuguese interbank money market, we analyse the micromechanics of the interbank market and model the co-movement of money market rates. We document banks trading at a range of maturities - mainly from over-night up to one week loans - and a seasonal pattern on market participation and interest rates. Further, failure to support the martingale hypothesis on interest rates can be tracked to banks specific characteristics and its share in market participation. An error correction model of the interbank market term structure provides evidence that rates respond to shocks originating either in banks’ demand for liquidity or monetary policy, although reactions vary across monetary policy regimes. Our results emphasise two blocks of interest rates moving together: the short end on one hand, with maturities up to 2 weeks; and the longer end, on the other, comprising the remaining maturities The rational expectations theory of interest rates does not hold in periods when there were institutional arrangements that prevented banks from yield curve arbitrage, and when there is uncertainty regarding the commitment of the central bank to pre-announced monetary policy targets.

Publication Type:	Thesis (Doctoral)
Subjects:	H Social Sciences > HG Finance
Departments:	Bayes Business School Bayes Business School > Bayes Business School Doctoral Theses Doctoral Theses

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