Stressed not Frozen: The Fed Funds Market in the Financial Crisis

Gara Afonso, Anna Kovner, Antoinette Schoar

NBER Working Paper No. 15806
Issued in March 2010
NBER Program(s):Asset Pricing Program, Corporate Finance Program

This paper examines the impact of the financial crisis of 2008 on the federal funds market, specifically the bankruptcy of Lehman Brothers. Rather than a complete collapse of lending in the presence of a market wide shock, we see that banks become more restrictive in which counterparties they lend to. After Lehman Brothers, we find that amounts and spreads become more sensitive to borrower bank characteristics. While the market does not contract dramatically, lending rates increase. Further, the market does not seem to expand to meet the increased demand predicted by the drop in other bank funding markets. We examine discount window borrowing as a proxy for unmet fed funds demand and find that the fed funds market is not indiscriminate. As expected, borrowers who access the discount window have lower ROA. When looking at the lender side we do not find that the characteristics of the lending bank importantly affect the amount of interbank loans a bank makes. In particular, we do not find that worse performing banks start hoarding liquidity and indiscriminately reduce their lending.

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Document Object Identifier (DOI): 10.3386/w15806

“Stressed, Not Frozen: The Federal Funds Market in the Financial Crisis GARA AFONSO, ANNA KOVNER andANTOINETTE SCHOAR* Article first published online: 19 JUL 2011 DOI: 10.1111/j.1540-6261.2011.01670.x © 2011 The American Finance Association Issue The Journal of Finance The Journal of Finance Volume 66, Issue 4, pages 1109–1139, August 2011 joint with Gara Afonso and Anna Kovner, September 2009, The Journal of Finance, forthcoming.

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