Electronic Trading and Financial Crisis Effects in the e-MID Interbank Market: A Multivariate Multiplicative Error Model Analysis

Abstract

We employ a multivariate multiplicative error model (MMEM) to explore the interplay between high-frequency return volatilities, trading volume, and trading intensities within the Italian Electronic Interbank Credit Market (e-MID). Our research question also aims at analysing the e-MID and, more specifically, the behaviour of traders in relation to the financial crisis. For this purpose, we consider four time periods: the first period before the first intervention by the ECB, the second period before the collapse of Lehman Brothers, and finally, the last intervention by the ECB. Utilising five-minute intervals, our analysis reveals a robust causal relationship among volatilities, volumes, and trading intensities in this electronic market, yielding highly significant coefficient estimates of the multivariate multiplicative error model (MMEM). However, these relationships change qualitatively, showing a shift in e-MID market behaviour before, during, and after the outbreak of the financial crisis. Notably, we find evidence that trading was in a Pareto optimum in the first period, but as soon as uncertainties hit the market, this Pareto optimum becomes unstable and breaks down completely in the last period of an extremely illiquid market state. To the best of our knowledge, this paper represents the first and inaugural empirical application of MMEM to an interbank credit market, contributing valuable insights into its intricate dynamics.