Short-term Market Interest Rates Research Articles

The Role of Maturity Gaps and Short-Term Market Interest Rates on Interest Rate Risk Exposure in Commercial Banks in Kenya

Commercial banks engage in maturity transformation and the term premium compensates them for bearing the associated duration risk. They are thus exposed to interest rate risk which is the bank's financial condition to adverse movements in interest rates and represents one of the key forms of risk that banks face as financial intermediaries. The study investigated the role of maturity gaps and short-term market interest rates on interest rate risk exposure in commercial banks in Kenya. This study adopted a panel data research design in methodology to analyze the critical interest rate risk drivers across the banking sector in Kenya. The study period covered 2005-2015. The study was informed by Expectations Hypothesis theory. Correlational research design was used and captured both cross-sectional and longitudinal dimensions of the effects of the variables under investigation that is Maturity gaps ratio (MGRs) and Interest Rate Sensitivity Ratio (IRSRs). The Interest rate risk (IRR) was expressed as a function of maturity gaps, interest rate sensitivity ratio and short-term market interest rates. STATA software was used as the tool for data manipulation. The findings indicated that that a rise in Maturity Gap 2, Maturity Gap 3, Maturity Gap 4, Maturity Gap 5, Interest Rate Sensitivity Ratio 2, Interest Rate Sensitivity Ratio 3, Interest Rate Sensitivity Ratio 4, 91DayTbill and 182DayTbill led to a decrease in the interest rate risk exposure for the commercial banks. However, an increase Maturity Gap 1, Interest Rate Sensitivity Ratio 1, Interest Rate Sensitivity Ratio 5 and 364DayTbill led to an increase in the interest rate risk exposure for the commercial banks. The study recommends that banks should have interest rate risk measurement frameworks that capture all material sources of interest rate risk and that measure the effect of interest rate changes in ways that are consistent with the scope of their activities. The assumptions underlying the system should be clearly understood by risk managers and bank management. Further, banks must establish and enforce operating limits and other practices that maintain exposures within levels consistent with their internal policies. The findings are important in formulation of policies and strategies for enhancing maturity transformation in the banking industry in the country. Keywords: Maturity Gap Ratio, Interest Rate Risk Sensitivity Ratio, Interest Rate Risk Exposure, Short-Term Market Interest Rates & Commercial Banks.

Central bank target rates and term structure of interest rates: A study of six Asia-Pacific countries

Granger causality tests find that the official interest rate (OIR) changes made by the central banks of Australia, China, India, South Korea, Philippines, and Taiwan cause OIR changes at other central banks, but no central bank dominates in its impact. Event study tests show that OIR announcements impact short-term market interest rates more than long-term market interest rates in their own countries. Our study shows that announcements by India and China have the largest impact on the other four countries. Markets anticipate OIR changes consistent with the objective of transparency by monetary authorities to reduce economy uncertainty for market participants.

Bank Lending and Interest on Excess Reserves

This paper analyzes the relationship between bank lending and the Federal Reserve's policy of paying interest on excess reserves (IOER). We argue that the Fed's IOER policy deviates from the standard interest-rate floor framework in ways that influence banks' incentives to hold loans and reserves. Using quarterly data from the start of 2000 through the third quarter of 2017, we find that banks' holdings of loans and reserves are related to GDP growth and employment but are not related to measures of loan demand or economic uncertainty. Accounting for these factors, banks' loan holdings are inversely related to both the rate of IOER and to its premium above short-term market interest rates. We estimate that the Fed's IOER policy accounts for more than half of the post-crisis decline in bank loan allocations.

Wavelet-based monetary and fiscal policy in the Euro area

This paper first applies the MODWT (Maximal Overlap Discrete Wavelet Transform) to Euro area quarterly GDP data from 1995 to 2014 to obtain the underlying cyclical structure of the GDP components. We then design optimal fiscal and monetary policy within a large state-space LQ-tracking wavelet decomposition model. Our study builds a MATLAB program that simulates optimal policy thrusts at each frequency range where: (1) both fiscal and monetary policy are emphasized, (2) only fiscal policy is relatively active, and (3) when only monetary policy is relatively active. The results show that the monetary authorities should utilize a strategy that influences the short-term market interest rate to undulate based on the cyclical wavelet decomposition in order to compute the optimal timing and levels for the aggregate interest rate adjustments. Given that central bank rates are adjusted in discrete steps, this implies that central bank monetary policy adjustments will be sub-optimal. We also find that modest emphasis on active interest rate movements can alleviate much of the volatility in optimal government spending, while rendering similarly favorable levels of aggregate consumption and investment. This research is the first to construct joint fiscal and monetary policies in an applied optimal control model based on the short and long cyclical lag structures obtained from wavelet analysis.

How Do Homeowners Choose Between Fixed and Adjustable Rate Mortgages?

Housing is the most important asset in the portfolio of most households. Understanding the households’ decision on housing finance has important implications from a policy perspective, due to the effects it may have on the housing prices, on the housing market stability and on household welfare. The theoretical literature on housing finance focused on figuring out the optimal choice between fixed rate mortgages (FRMs) and adjustable rate mortgages (ARMs). We argue that the standard economic criteria are sometimes inadequate to explain household’s choices, which may be motivated by psychological factors. In other words, we claim that household’s choice depends only partially on the findings of the theoretical literature. We examine the effect of changes in the short-term market interest rate on the households’ choice between FRMs and ARMs. We test this effect using a unique data provided to us by the Bank of Israel, which contains detailed information on the household’s decision between FRM and ARM contracts in Israel in the past decade. The results of our analysis demonstrate a significant association between FRM preference and short-term interest rate reduction. Moreover, we find that the change in the short-term interest rate is more salient to the borrowers in periods of a high interest rate environment. We attribute these findings to Tversky and Kahneman (1974) availability and representativeness heuristics.

Monetary Policy Spillovers across the Pacific when Interest Rates Are at the Zero Lower Bound

To conduct monetary policy effectively, central banks need to understand the transmission of monetary policy into financial markets. In this paper we investigate the effects of Japanese and U.S. monetary policy shocks on their own asset markets, and the spillovers into each other's markets. Because short-term nominal interest rates have been effectively zero in Japan since January 1998 and in the United States from late 2008, however, monetary policy shocks cannot be quantified by considering observable changes in short-term market interest rates. Therefore, in our analysis we use a shadow short rate―a quantitative measure of overall conventional and unconventional monetary policy that is estimated from the term structure of interest rates. Our results suggest that the operation of monetary policy at the zero lower bound of interest rates alters the transmission of shocks. In particular, we find a limited response of exchange rates during the first episode of unconventional monetary policy in Japan but a significant impact since 2006.

The bank lending channel of monetary policy in EU countries during the global financial crisis

The study examines the existence of the bank lending channel of monetary policy in European Union (EU) countries. The paper advances current research on the monetary transmission mechanism in the following ways: Firstly, we analyze the differences between ‘old’ Economic Monetary Union (EMU) and ‘new’ EU countries. Secondly, we examine the key bank characteristics and monetary policy indicators that may have an impact on the bank lending channel. We assume that short-term market interest rates and monetary aggregate M2 affect banks' activities. We apply the generalized method of moments (GMM) with pooled data from 1999 to 2012. We show that in the pre-crisis period the effect of changing the short-term market interest rates on the bank lending channel of monetary policy is more pronounced among ‘old’ EMU countries, whereas the effect of M2 is significant during the period of the global financial crisis (GFC) among ‘old’ EMU countries. Last but not least the important finding is that banks in ‘new’ EU countries react differently to monetary shocks.

Household Debt and Monetary Policy: Revealing the Cash-Flow Channel

We study the effect of monetary policy on spending when households hold debt with variable interest rates. When interest rates on outstanding loans vary with the short-term market interest rate, monetary policy has a direct and immediate effect on households' expenses and disposable income. If households are borrowing constrained, they will respond to a shock to disposable income by adjusting their spending. As a result, a monetary policy-induced interest rate change leads to a larger change in consumption than what is predicted by the elasticity of intertemporal substitution. We examine this cash-flow channel of monetary policy using administrative data on Swedish households. We estimate a strong and statistically significant response in spending to changes in interest expenses. More specifically, we estimate a marginal propensity to consume (including durable consumption) that is around unity or even higher in response to monetary-policy induced changes in interest expenses. For example, highly indebted households with adjustable rate mortgages reduce consumption growth by several percentage points more in response to a one percentage point increase in the household interest rate than households with little debt or fixed rate mortgages. Our findings imply that monetary policy will have a stronger effect on real economic activity when households are highly indebted and have adjustable rate mortgages.

Euro Area Monetary and Fiscal Policy Tracking Design in the Time-Frequency Domain

This paper first applies the MODWT (Maximal Overlap Discrete Wavelet Transform) to Euro Area quarterly GDP data from 1995 – 2014 to obtain the underlying cyclical structure of the GDP components. We then design optimal fiscal and monetary policy within a large state-space LQ-tracking wavelet decomposition model. Our study builds a MATLAB program that simulates optimal policy thrusts at each frequency range where: (1) both fiscal and monetary policy are emphasized, (2) only fiscal policy is relatively active, and (3) when only monetary policy is relatively active. The results show that the monetary authorities should utilize a strategy that influences the short-term market interest rate to undulate based on the cyclical wavelet decomposition in order to compute the optimal timing and levels for the aggregate interest rate adjustments. We also find that modest emphasis on active interest rate movements can alleviate much of the volatility in optimal government spending, while rendering similarly favorable levels of aggregate consumption and investment. This research is the first to construct joint fiscal and monetary policies in an applied optimal control model based on the short and long cyclical lag structures obtained from wavelet analysis.

What determines the yen swap spread?

We investigate if Japanese yen denominated interest rate swap spreads price risks in addition to liquidity and default risk. These additional risks include: the time-varying correlation between interest rates of different types and maturities; business cycle risk; and market skewness risk. Our analysis, over a number of different maturities and sample periods, supports the existence of an additional risk premium. We also show that the time-varying correlation between short term market interest rates (e.g., TIBOR) and the longer term Government bond yield (e.g., Gensaki) is of particular importance. Japanese yen swap spreads are shown to contain both pro-cyclical and counter-cyclical elements of business cycle risk, positive risk premia for skewness risk and variable risk premia for correlation risk (between fixed and floating interest rates).

Bank Risks, Monetary Shocks and the Credit Channel in Brazil: Identification and Evidence from Panel Data

Using a large database of bank financial statements, this paper investigates the determinants of the bank lending channel (BLC) of monetary transmission in Brazil between 1995 and 2012. I extend the standard empirical approach in two main ways. First, I apply a micro-founded strategy for disentangling demand from supply shifts in credit. Using this identification scheme, I show that lending supply is negatively correlated with the short-term market interest rate over the long period. The sensitivity of credit supply to monetary shocks is not related to the bank characteristics generally used in the empirical literature, whereas a proxy of the individual bank external finance premium (EFP) tends to capture financial constraints better than size, liquid assets or capitalization ratios. However, the patterns of the BLC have changed since the onset of the global financial crisis. In the post-crisis period, the money market rate does not affect the lending supply of the average bank anymore, while small banks and those lacking access to long-term funds appear more sensitive to monetary shocks in some estimations. Second, I check whether several types of uncertainty may drive the BLC, beyond liquidity risk. Over the long period, I find evidence that higher market risk borne by banks’ securities portfolios (captured by a longer duration of public debt bonds) and lower uncertainty in the money market (captured by a lower volatility of rates) appear to consistently enhance the effectiveness of monetary policy through the BLC.

Bank risks, monetary shocks and the credit channel in Brazil: Identification and evidence from panel data

Using a large database of bank financial statements, this paper investigates the determinants of the bank lending channel (BLC) of monetary transmission in Brazil between 1995 and 2012. I extend the standard empirical approach in two main ways. First, I apply a micro-founded strategy for disentangling demand from supply shifts in credit. Using this identification scheme, I show that lending supply is negatively correlated with the short-term market interest rate over the long period. The sensitivity of credit supply to monetary shocks is not related to the bank characteristics generally used in the empirical literature, whereas a proxy of the individual bank external finance premium (EFP) tends to capture financial constraints better than size, liquid assets or capitalization ratios. However, the patterns of the BLC have changed since the onset of the global financial crisis. In the post-crisis period, the money market rate does not affect the lending supply of the average bank anymore, while small banks and those lacking access to long-term funds appear more sensitive to monetary shocks in some estimations. Second, I check whether several types of uncertainty may drive the BLC, beyond liquidity risk. Over the long period, I find evidence that higher market risk borne by banks' securities portfolios (captured by a longer duration of public debt bonds) and lower uncertainty in the money market (captured by a lower volatility of rates) appear to consistently enhance the effectiveness of monetary policy through the BLC.

The Informational Content of SMP Deposit Auctions in Forecasting Short-Term Repurchase Agreement Interest Rates (Dissertation)

This paper analyzes the term deposit sterilizing open market operations conducted by the Eurosystem between May 2010 and June 2014 in the context of the Securities Market Program (SMP). The SMP operations involved outright purchases of government debt securities in the secondary market with a view of lowering the credit spreads of stressed Euro periphery countries after the eruption of the Greek sovereign debt crisis in 2010. I investigate the details of the program, the execution of the term deposit auctions and their effects on short-term repurchase agreement (repo) interest rates. To do this I employ a stochastic model to determine how market participants bid at the auctions as well as several econometric models to look into how various monetary and market rates such as short-term repo, the MRO and the SMP deposit rates affect each other. The key result is that information extracted from SMP deposit auctions can be used by the central bank in order to create more accurate conditional forecasts of short-term money market interest rates, information that is not present in other regular Open Market Operations conducted by the Eurosystem. Lastly the case for an SMP debt certificate is presented which can increase the supply of safe assets in the Euro money market and help in the transmission of monetary policy.

The Pricing of Credit Derivatives and Estimation of Default Probability

Under the native-born model of default and the circular model of default, we take the price of credit derivatives into account. It’s supposed that the short-term market interest rates are based on Vasicek model in this article. Firstly, we calculate the price of default-free bonds in zero-coupon bond. Then, we give the default-intensity expressions under the two models. We calculate the prices of default-free bonds under the two default models. For different situations, we estimate the parameters by maximum likelihood estimation method and calculate the default probability of the company. From the analysis of the result, we find that the result conforms to reality. So the models of default intensity we suppose in the bond pricing are reasonable.

How Homeowners Choose between Fixed and Adjustable Rate Mortgages?

Housing is the most important asset in the portfolio of most households. Understanding the households’ decision on housing finance has important implications from a policy perspective, due to the effects it may have on the housing prices, on the housing market stability and on household welfare. The theoretical literature on housing finance focused on figuring out the optimal choice between Fixed Rate Mortgages (FRM) and Adjustable Rate Mortgages (ARM). We argue that the standard economic criteria are sometimes inadequate to explain household’s choices, which may be motivated by psychological factors. In other words, we claim that household’s choice depends only partially on the findings of the theoretical literature. We examine the effect of changes in the short term market interest rate on the households’ choice between fixed rate mortgages (FRM) and adjustable rate mortgages (ARM). We test this effect using a unique data provided to us by the Bank of Israel, which contains detailed information on the household’s decision between fixed and adjustable rate mortgage contracts in Israel in the past decade. The results of our analysis demonstrate a significant association between FRM preference and short term interest rate reduction. Moreover, we find that the change in the short term interest rate is more salient to the borrowers in periods of a high interest rate environment. We attribute these findings to Tversky and Kahneman (1974) availability and representativeness heuristics.

What Drive Market Interest Rates in China?

China’s interest rate market is unique because its central bank sets a term structure of official interest rates on bank deposits and loans as well as money supply. In this paper we explore both theoretically and empirically how market interest rates in China are related to economic fundamentals, bond demand and supply, and official interest rates and money supply. We first develop a theoretic model with both preferred habitat investors and arbitrageurs and show how the short term and long term market interest rates are related to these factors, and then empirically test their relationships. Different from the interest rate market in the U.S., we find that while the short-term rate in China is closely tied to the official interest rates and bond demand, it has a weak relationship with economic variables. In contrast, we find that the long-term rates are sensitive to the industrial production growth and inflation rate as well as the official interest rates and bond demand. We attribute these results to the unique monetary policy system in China.

Relationship between Global Imbalance and the Subprime Crisis in the U.S.

This paper investigates wether there was a systematic linkage between global imbalance and the subprime crisis by focusing on analysis of the Greenspan’s Conundrum hypothesis. First, I found that, before the subprime crisis, capital inflows from the countries recording current account surplus mainly caused the long-term Treasury bond rate to be maintained at low level. However, contrary to the Treasury bond rate, the short-term market interest rates sharply increased since 2004. The U.S. house prices was mainly affected by the market interest rates rather than by the long-term Treasury Bond rate because most of subprime lending were in the form of Adjustable-rate mortgages. It is also found that the market interest rates were substantially influenced by the Fed's monetary policy. Thus even though I partially admit the Greenspan’s Conundrum hypothesis in which the low long-term interest rate resulted in the U.S. asset bubbles, it could not be a significant cause of the subprime crisis.

Term Structure and the Sluggishness of Retail Bank Interest Rates in Euro Area Countries

This paper analyses the pricing of bank loans and deposits in euro area countries. We show that retail bank interest rates adjust not only to changes in short-term interest rates but also to long-term interest rates. This result, which is arguably intuitive for long-term retail bank rates, is also confirmed for bank interest rates on short-term instruments. The transmission of changes in short-term market interest rates along the yield curve is found to be a key factor explaining the sluggishness of retail bank interest rates. We also show that in the cases where we cannot reject that the adjustment of retail rates has changed since the introduction of the euro, this adjustment has become faster.

Proposed Revision to the Federal Reserve's Discount Window Lending Programs

The Board of Governors' Regulation A currently authorizes the Federal Reserve Banks to operate three main discount window programs: adjustment credit, extended credit, and seasonal credit. On May 17, 2002, the Board published for public comment a proposed amendment to Regulation A that would establish two new discount window programs called primary credit and secondary credit as replacements for adjustment and extended credit. Primary credit would be available for very short terms, ordinarily overnight, to depository institutions that are in generally sound financial condition. Secondary credit would be available, subject to Reserve Bank approval and monitoring, for depository institutions that did not qualify for primary credit. The interest rate on primary credit would usually be above short-term market interest rates, including the federal funds rate, as opposed to the current situation in which the discount rate (the interest rate for adjustment credit) is typically below money market interest rates. Because of the above-market rate, the restrictions currently employed to limit access to adjustment credit will be unnecessary for primary credit. The primary credit program would be broadly similar to mechanisms adopted by many other major central banks to provide credit at the margin at an above-market rate.

Persistence and Volatility in Short-term Interest Rates

It is important for monetary policy makers to know how closely money market rates follow the policy rates they set. This paper looks at the volatility and persistence of divergences between short-term market interest rates away from policy rates. This may also offer insights into the effectiveness of various approaches that central banks employ to smooth interest rate volatility, such as requiring minimum reserves. Using data for Germany, Italy and the United Kingdom, we find that in all three countries there are significant temporary divergences, although the average divergence is close to zero.