Do Central Bank Liquidity Facilities Affect Interbank Lending Rates?

by Jens H.E. Christensen of the Federal Reserve Bank of San Francisco,
Jose A. Lopez of the Federal Reserve Bank of San Francisco, and
Glenn D. Rudebusch of the Federal Reserve Bank of San Francisco

June 2, 2009

Abstract: In response to the global financial crisis that started in August 2007, central banks provided extraordinary amounts of liquidity to the financial system. To investigate the effect of central bank liquidity facilities on term interbank lending rates, we estimate a six-factor arbitrage-free model of U.S. Treasury yields, financial corporate bond yields, and term interbank rates. This model can account for fluctuations in the term structure of credit risk and liquidity risk. A significant shift in model estimates after the announcement of the liquidity facilities suggests that these central bank actions did help lower the liquidity premium in term interbank rates.

JEL Classification: G12.

Keywords: Central bank liquidity facilities, LIBOR, term structure modeling, arbitrage-free Nelson-Siegel models.

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