Unique transaction-level data for nearly every federal funds transaction made during the first quarter of 1998 forms the foundation for this in-depth exploration of the federal funds market. Unlike previous studies that have relied on aggregate and typically infrequent measures of federal funds market participation, the transaction-level data exploited here allows a closer look at the microstructure of the market. The paper explores the relationship between bank size and participation in the funds market and discovers that even the largest banks are frequently net sellers of funds. A time-of-day pattern is uncovered, as is significant market concentration. Preliminary exploration into trading patterns, or networks, is conducted, and the existence of relationship lending in the interbank market is investigated.
This study provides evidence that banks are effective monitors of their peers by showing that the interest rate paid on federal funds transactions reflects differences in credit risk across borrowers. In addition, the size and relative importance in the funds market of the trading institutions are shown to affect the rates charged for overnight borrowing, thereby providing insight into the nature of competition in the federal funds market. Transaction volume and size-of-transaction effects are uncovered, as is evidence of relationship banking between banks. These results are made possible by unique data identifying individual federal funds transactions.
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