Liquidity Auction Mechanism Design And The Interbank Market

After the financial crisis in 2008,in order to achieve its monetary policy target,the European Central Bank commonly used the posted price mechanism with full allotment in MROs.The paper studies whether the mechanism design in the central bank liquidity auctions matters for the interbankmoney market interest rate levels and volatility.Furthermore,the paper compares different mechanisms to sell liquidityin terms of revenue,efficiency and auction stage interest rate levels and volatility.Most importantly,the paper askswhich mechanism is the best at implementing the target policy interest rates to the interbank market and whatare the trade-os involved.The paper constructs a relatively general model of strategic bidding with interdependentvaluations,and combine it with a stylized model of the interbank market.The novel feature of the model is thatthe expectations of the interbank market outcomes determine the valuations in the liquidity auctions.The modelcaptures the relevant features of how the European Central Bank sells liquidity.The paper uses simulations to comparediscriminatory price,uniform price and Vickrey auctions to a posted price mechanism with full allotment.Inorder to analyze interactions between the primary and the secondary market under four different mechanisms,the paper needs to make a lot of assumptions and simplifications.Given this caveat,the paper finds that posted prices with fullallotment is clearly the superior alternative in terms of implementing the policy interest rate to the interbankmarkets.This comes at the cost of less revenue compared to the revenue maximizing discriminatory price auction,but surprisingly,will not result in effciency losses compared even to the Vickrey auction.