Money markets are a cornerstone of the financial system that comprises
'money-like instruments' - debt securities with less than one year to
maturity. These markets were at the epicenter of the financial crisis
with dysfunctional money markets being one of the reasons for Lehman
Brother's default. Consequently, money markets became the focus of
financial regulators and went through major post-crisis reforms. In this
research project, we focus on three roles of money markets in the post-crisis
environment.
First, money market rates act as proxies for the risk-free interest rate.
Virtually every textbook in financial economics uses the 'risk-free rate'
to characterize the return on safe assets and for discounting of future
cashflows. In theory, the risk-free rate characterizes the simplest possible
investment opportunity. In practice, however, deciding which interest rate
should be the 'the risk-free rate' is a difficult question that became even
more difficult after the financial crisis. We discuss a variety of candidates for
the risk-free rate and examine the impact of post-crisis financial regulation on
these benchmarks.
Second, the role of short-term financing as a lubricant for the financial
system. Banks and security dealers rely on short-term financing when
they intermediate the supply and demand for different securities across
time (market making). Hence, a stable short-term financing market directly
supports market liquidity and the ease of trading financial assets. We
investigate the impact of post-crisis regulatory reforms (which have arguably
increased banks' short-term borrowing costs) on the corporate bond market.
Third, the role of money markets in implementing monetary policy. In this
project, we use Norwegian data on liquidity auctions - transactions in which
banks pledge collateral with the central bank to obtain cash - and examine
how Norges bank's collateral policy (i.e. which collateral is accepted) affects
money market rates.
For more information on personal information used in research projects, see https://www.bi.edu/research/research-ethics-at-bi/.
