A Micro Model of the Federal Funds Market

Authors

  • THOMAS S. Y. HO,

  • ANTHONY SAUNDERS

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    • Ho is from the Graduate School of Business, New York University and Saunders is from the Graduate School of Business, New York University and the Federal Reserve Bank of Philadelphia. We would like to thank the Salomon Brothers Center for the Study of Financial Institutions for its financial support. We would also like to thank Bill Silber, Ken Garbade, Paul Wachtel, Bob Hetzel, Chris James, V. Vance Roley, Paul Spindt, Peter Lloyd-Davies, and William Poole for their helpful comments on earlier drafts of this paper.


ABSTRACT

This paper demonstrates that valuable insights into the determination of Federal funds rates can be gained through modeling the micro-decisions of market participants. Fed fund demand functions are derived for different bank valuation functions and several implications are discussed. Specifically, it is: (i) possible to rationalize the observation that large banks are net purchasers and small banks net sellers of Fed funds; (ii) to explain the positive spread of Fed funds rates over other short-term money market rates; and (iii) to link the size of this spread to the Federal Reserve's underlying monetary policy strategy.

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