Surplus Liquidity: Implications for Central Banks

Surplus liquidity occurs where cashflows into the banking system persistently exceed withdrawals of liquidity from the market by the central bank. This is reflected in holdings of reserves in excess of the central bank's required reserves. The occurrence of surplus liquidity is widespread, covering many countries around the world. Historically, it has been observed most often in Soviet, wartime and transitional countries. Transitional economies, for example, often attract large capital inflows as the economy opens and undergoes privatisation. The effect of these inflows on liquidity is often magnified by central bank intervention in the foreign exchange market when there is upward pressure on the domestic currency. In the wartime economy, consumption is restricted and large amounts of involuntary savings accumulate until goods and services eventually become more widely available. Soviet-style economies have displayed widespread shortages and administered prices. This creates a situation of repressed inflation, whereby prices are too low relative to the money stock, leaving individuals with excess real balances. The importance of surplus liquidity for central banks is threefold and lies in its potential to influence: (1) the transmission mechanism of monetary policy; (2) the conduct of central bank intervention in the money market, and (3) the central bank's balance sheet and income.Surplus Liquidity, Implications,Central Banks

Bidding and Information: Evidence from Gilt-Edged Auctions

This paper looks in detail at pricing in Gilt Auctions. It compares the prices received at all auctions between May 1987 and February 1995 with both the When-Issued price (the pre- auction market for delivery of the auction stock) and the price of a comparable parent stock (when one existed). The paper finds a marked difference in performance between non-fungible stocks (when a parent exists but the tranche cannot be traded identically with the parent until a few weeks after the auction due to part payments and different first coupons) and fully-fungible stocks (when the parent and tranche trade identically from auction day). The average auction price received for non-fungible stock was significantly below both the When-issued price (about 13p per o100) and the adjusted parent price (about 24p per o100). In the case of fully fungible auctions there was no discernable price difference between auction stock, When-issued, or adjusted parent stock price. Auction prices below comparable secondary market ones is a common result for Government debt auctions (similar results have been found for the US, Germany and Mexico). The explanation usually given is that uncertainty about the correct price leads bidders to shade down their bids. The paper examines this explanation and finds that although it can help explain the results for non- fungible auctions (measures of uncertainty seem to be correlated with the degree of price difference) it does not explain the markedly different results observed for fully-fungible auctions since the dispersion of bids for these auctions is no less than for non-fungible ones suggesting that some uncertainty still exists. This is a slightly revised version of a paper that was published in July 1995 as part of the Debt Management Review.

Surplus liquidity Implications for Central Banks

Includes bibliographical references. Title from coverSIGLEAvailable from British Library Document Supply Centre- DSC:5180. 56235(no 3) / BLDSC - British Library Document Supply CentreGBUnited Kingdo

Distributions Implied by Exchange Traded Options: A Ghost’s Smile?

A new and easily applicable method for estimating risk neutral distributions (RND) implied by American futures options is proposed. It amounts to inverting the Barone-Adesi and Whaley method (1987) (BAW method) to get the BAW implied volatility smile. Extensive empirical tests show that the BAW smile is equivalent to the volatility smile implied by corresponding European options. Therefore, the procedure leads to a legitimate RND estimation method. Further, the investigation of the currency options traded on the Chicago Mercantile Exchange and OTC markets in parallel provides us with insights on the structure and interaction of the two markets. Unequally distributed liquidity in the OTC market seems to lead to price distortions and an ensuing interesting ‘ghost-like ’ shape of the RND density implied by CME options. Finally, using the empirical results, we propose a parsimonious generalisation of the existing methods for estimating volatility smiles from OTC options. A single free parameter signi…cantly improves the …t