Overbidding in Fixed Rate Tenders: The Role of Exposure Risk

Abstract

The fixed rate tender is one of the main operational formats used by central banks in the implementation of their monetary policies. While academic research has largely dismissed the procedure for its tendency to encourage overbidding, central banks such as the ECB and the Bank of England have continued using it. We elaborate on this apparent conflict by considering an auction-theoretic setting with privately known declining marginal valuations. Since overbidding entails exposure risk, an equilibrium may exist even if bids are costless and the intended amount is pre-announced. In fact, rationing may occur with certainty. The equilibrium is also robust under adaptive expectations. However, the resulting allocation is typically inefficient. Empirical proxies of exposure risk are significant in both Euro and Sterling operations. Our findings have implications, in particular, for the potential re-introduction of rationing in the main refinancing operations of the Eurosystem.