Has the Crisis Passed? Assessing the Effectiveness of the Term Auction Facility

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Abstract/Contents

Abstract: A key feature of the ongoing financial crisis has been the dramatic and persistent increase in the spreads between the federal funds rate and longer term inter-bank loans. The Federal Reserve has tried to combat the rise in these spreads by injecting liquidity into the market through the creation of measures such as the Term Auction Facility (TAF). The effectiveness of these measures depends on the causes of increased spreads. Is it the liquidity risk premium that is driving inter-bank rates higher? Or instead, are rates being pushed higher by elevated credit risk premiums resulting from the increased risk of default by banks? Using a no-arbitrage model for defaultable bond pricing, I decompose the inter-bank rate into its liquidity, credit and term risk premiums. I then estimate the effectiveness of the TAF in reducing liquidity premiums and find that it had a moderate effect on spreads, indicating that the liquidity risk premium has been a factor in the inter-bank market. I end with a discussion of the implications this result has on future Fed policy towards lowering spreads in the inter-bank market.

Type of resource	text
Date created	May 2009

Author	Khanna, Kunal
Primary advisor	Taylor, John B.
Degree granting institution	Stanford University, Department of Economics

Subject	Stanford Department of Economics
Subject	federal funds rate
Subject	inter-bank loans
Subject	Federal Reserve
Subject	Term Auction Facility
Subject	liquidity risk premium
Subject	credit risk premium
Subject	term risk premium
Genre	Thesis

Location	https://purl.stanford.edu/ww826tf8064

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Preferred Citation: Khanna, Kunal. (2009). Has the Crisis Passed? Assessing the Effectiveness of the Term Auction Facility. Stanford Digital Repository. Available at: https://purl.stanford.edu/ww826tf8064

Stanford University, Department of Economics, Honors Theses

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