Modeling the Euro overnight rate

Abstract

This paper describes the evolution of the daily Euro overnight interest rate (EONIA) by using several models containing the jump component such as a single regime ARCH-Poisson-Gaussian process, with either a piecewise function or an autoregressive conditional specification (ARJI) for the jump intensity, and a two regime-switching process with jumps and time varying transition probabilities. To model the jump intensity, we include the following effects which are significant for the occurrence of jumps such as: (1) the end of maintenance period effect because of reserve requirements, (2) the end of month effect, also known as the calendar day effect, caused mainly by the accounting adjustments and finally, (3) the meeting effect caused by the fortnightly meetings of the Governing Council of the European Central Bank (ECB). These effects lead to a better performance and several of them are also included for the behavior of the transition probabilities. Since the target of the ECB is keeping the EONIA rate close to the official rate, we have modeled the conditional mean of the overnight rate series as a reversion process to the official rate distinguishing two alternative speeds of reversion, in concrete, a different speed if EONIA is higher or lower than the official rate. We also study the jumps of the EONIA rate around the ECB's meetings by using the ex-post probabilities of the ARJI model. Finally, we develop an out-of-sample forecasting analysis to measure the performance of the different candidate models.JEL classification: C13, C22, E43, E52.

Demand for reserves and the central bank’s management of interest rates

“…This reasoning leads to the hypothesis of a steeper demand curve towards the end of the maintenance period. Benito et al (2006) empirically analyze the volatility of the Euro ON interest rate (EONIA) and show that the volatility of the EONIA is highest at the end of the maintenance period. Overall we expect that ON interest rates are very sensitive with respect to reserves on the last days of the maintenance period and thus tend to be particularly volatile on these days.…”

Statistical properties and economic implications of jump-diffusion processes with shot-noise effects

“…This implies E [U ] = 0. The assumption of a lognormal distribution for jump sizes is common in the JD literature (see, for instance, Merton, 1976) 8 . Moreover, it is convenient as it decreases the number of parameters under estimation 9 .…”

Interest rate setting on the Swiss Franc repo market

“…This mainly as repo rates jumped from 17 Repos undertaken on 11 September 2001 and on following days are not excluded, as rates did not show any unusual pattern. 18 See Benito et al (2006) for an empirical analysis on the volatility of the Euro ON interest rate (EONIA). 19 Additionally the intra-class correlation of the interest rates by individual (cash taker ID) was calculated.…”