• Payment Instruments and Collateral in the Interbank Payment System
  Hajime Tomura

  Abstract

  This paper presents a three-period model to analyze the need for bank reserves in the presence of other liquid assets like Treasury securities. If a pair of banks settle bank transfers without bank reserves, they must prepare extra liquidity for interbank payments, because depositors’ demand for timely payments causes a hold-up problem in the bilateral settlement of bank transfers. In light of this result, the interbank payment system provided by the central bank can be regarded as an implicit interbank settlement contract to save liquidity. The central bank is necessary for this contract as the custodian of collateral. Bank reserves can be characterized as the balances of liquid collateral submitted by banks to participate into this contract. This result explains the rate-of-return dominance puzzle and the need for substitution between bank reserves and other liquid assets simultaneously. The optimal contract is the floor system, not only because it pays interest on bank reserves, but also because it eliminates the overthe-counter interbank money market. The model indicates it is efficient if all banks share the same custodian of collateral, which justifies the current practice that a public institution provides the interbank payment system.

  Introduction

  Base money consists of currency and bank reserves. Banks hold bank reserves not merely to satisfy a reserve requirement, but also to make interbank payments to settle bank transfers between their depositors. In fact, the daily transfer of bank reserves in a country tends to be as large as a sizable fraction of annual GDP. Also, several countries have abandoned a reserve requirement. Banks in these countries still use bank reserves to settle bank transfers.

  2016.09

  PDF File

• A Double Counting Problem in the Theory of Rational Bubbles
  Hajime Tomura

  Abstract

  In a standard overlapping generations model, the unique equilibrium price of a Lucas’ tree can be decomposed into the present discounted value of dividends and the stationary monetary equilibrium price of fiat money, the latter of which is a rational bubble. Thus, the standard interpretation of a rational bubble as the speculative component in an asset price double-counts the value of pure liquidity that is already part of the fundamental price of an interest-bearing asset.

  Introduction

  A rational bubble is usually modeled as an intrinsically useless asset. As shown by Tirole (1985), it attains a positive market value if it is expected to be exchangeable for goods in the future. It becomes worthless if it is expected to be worthless in the future, given that it has no intrinsic use. This property of self-fulfilling multiple equilibria has been used to explain a large boom-bust cycle in an asset price, as a stochastic transition between the two equilibria can generate a boom-bust cycle without any associated change in asset fundamentals.

  2016.05

  PDF File

• Payment Instruments and Collateral in the Interbank Payment System
  Hajime Tomura

  Abstract

  This paper presents a three-period model to analyze why banks need bank reserves for interbank payments despite the availability of other liquid assets like Treasury securities. The model shows that banks need extra liquidity if they settle bank transfers without the central bank. In this case, each pair of banks sending and receiving bank transfers must determine the terms of settlement between them bilaterally in an overthe-counter transaction. As a result, a receiving bank can charge a sending bank a premium for the settlement of bank transfers, because depositors’ demand for timely payments causes a hold-up problem for a sending bank. In light of this result, the large value payment system operated by the central bank can be regarded as an interbank settlement contract to save liquidity. A third party like the central bank must operate this system because a custodian of collateral is necessary to implement the contract. This result implies that bank reserves are not independent liquid assets, but the balances of collateral submitted by banks to participate into a liquidity-saving contract. The optimal contract is the floor system. Whether a private clearing house can replace the central bank depends on the range of collateral it can accept.

  Introduction

  Base money consists of cash and bank reserves. Banks hold bank reserves not merely to satisfy a reserve requirement, but also to make interbank payments to settle bank transfers between their depositors. In fact, the daily transfer of bank reserves in a country tends to be as large as a sizable fraction of annual GDP. Also, several countries have abandoned a reserve requirement. Banks in these countries still use bank reserves to settle bank transfers.

  2015.08

  PDF File

• Rational Bubble on Interest-Bearing Assets
  Hajime Tomura

  Abstract

  This paper compares fiat money and a Lucas’ tree in an overlapping generations model. A Lucas’ tree with a positive dividend has a unique competitive equilibrium price. Moreover, the price converges to the monetary equilibrium value of fiat money as the dividend goes to zero in the limit. Thus, the value of liquidity represented by a rational bubble is part of the fundamental price of a standard interestbearing asset. A Lucas’ tree has multiple equilibrium prices if the dividend vanishes permanently with some probability. This case may be applicable to public debt, but not to stock or urban real estate.

  Introduction

  Fiat money and a rational bubble have the same property as liquidity. As shown by Samuelson (1958) and Tirole (1985), they attain a positive market value if they are expected to be exchangeable for goods in the future. It is also common that they become worthless if they are expected to be worthless in the future, given no intrinsic use of them. This property of selffulfilling multiple equilibria has been used to explain a large boom-bust cycle in an asset price, because a stochastic transition between the two equilibria can generate a boom-bust cycle by speculation without any change in asset fundamentals.

  2015.01

  PDF File

• Payment Instruments and Collateral in the Interbank Payment System
  Hajime Tomura

  Abstract

  This paper presents a three-period model to analyze the endogenous need for bank reserves in the presence of Treasury securities. The model highlights the fact that the interbank market is an overthe-counter market. It characterizes the large value payment system operated by the central bank as an implicit contract, and shows that the contract requires less liquidity than decentralized settlement of bank transfers. In this contract, bank reserves are the balances of liquid collateral pledged by banks. The optimal contract is equivalent to the floor system. A private clearing house must commit to a time-inconsistent policy to provide the contract.

  Introduction

  Base money consists of cash and bank reserves. Banks do not hold bank reserves merely to satisfy a reserve requirement, but also to settle the transfer of deposit liabilities due to bank transfers. In fact, the average figure for the daily transfer of bank reserves is as large as a sizable fraction of annual GDP in the country. Also, several countries have abandoned a reserve requirement. Banks in these countries still settle bank transfers through a transfer of bank reserves

  2014.12

  PDF File

• Investment Horizon and Repo in the Over-the-Counter Market
  Hajime Tomura

  Abstract

  This paper presents a three-period model featuring a short-term investor in the over-the-counter bond market. A short-term investor stores cash because of a need to pay cash at some future date. If a short-term investor buys bonds, then a deadline for retrieving cash lowers the resale price of bonds for the investor through bilateral bargaining in the bond market. Ex-ante, this hold-up problem explains the use of a repo by a short-term investor, the existence of a haircut, and the vulnerability of a repo market to counterparty risk. This result holds without any uncertainty about bond returns or asymmetric information.

  Introduction

  A repo is one of the primary instruments in the money market. In this transaction, a shortterm investor buys long-term bonds with a repurchase agreement in which the seller of the bonds promises to buy back the bonds at a later date. From the seller’s point of view, this transaction is akin to a secured loan with the underlying bonds as collateral. A question remains, however, regarding why a short-term investor needs a repurchase agreement when the investor can simply resell bonds to a third party in a spot market. The answer to this question is not immediately clear, as the bonds traded in the repo market include Treasury securities and agency mortgage-backed securities, for which a secondary market is available.

  2014.11

  PDF File

• Payment Instruments and Collateral in the Interbank Payment System
  Hajime Tomura

  Abstract

  This paper analyzes the distinction between payment instruments and collateral in the interbank payment system. Given the interbank market is an over-the-counter market, decentralized settlement of bank transfers is inefficient if bank loans are illiquid. In this case, a collateralized interbank settlement contract improves efficiency through a liquidity-saving effect. The large value payment system operated by the central bank can be regarded as an implicit implementation of such a contract. This result explains why banks swap Treasury securities for bank reserves despite that both are liquid assets. This paper also discusses if a private clearing house can implement the contract.

  Introduction

  Base money consists of cash and bank reserves. The latter type of money is used by banks when they settle bank transfers between their depositors. Typically, the daily transfer of bank reserves in a country is as large as a sizable fraction of annual GDP. This large figure implies that banks do not hold bank reserves merely to satisfy a reserve requirement, but also to settle the transfer of deposit liabilities due to daily bank transfers. In fact, several countries have abandoned a reserve requirement. Banks in these countries still settle bank transfers through a transfer of bank reserves.

  2014.11

  PDF File

• Investment Horizon and Repo in the Over-the-Counter Market
  Hajime Tomura

  Abstract

  This paper presents a three-period model featuring a short-term investor in the over-the-counter bond market. A short-term investor stores cash because of a need to pay cash at some future date. If a short-term investor buys bonds, then a deadline for retrieving cash lowers the resale price of bonds for the investor through bilateral bargaining in the bond market. Ex-ante, this hold-up problem explains the use of a repo by a short-term investor, the existence of a haircut, and the vulnerability of a repo market to counterparty risk. This result holds without any uncertainty about bond returns or asymmetric information.

  Introduction

  Many securities primarily trade in an over-the-counter (OTC) market. A notable example of such securities is bonds. The key feature of an OTC market is that the buyer and the seller in each OTC trade set the terms of trade bilaterally. There has been developed a theoretical literature analyzing the effects of this market structure on spot trading, such as Spulber (1996), Rust and Hall (2003), Duffie, Gˆarleanu, and Pedersen (2005), Miao (2006), Vayanos and Wang (2007), Lagos and Rocheteau (2010), Lagos, Rocheteau and Weill (2011), and Chiu and Koeppl (2011), for example. This literature typically models bilateral transactions using search models and analyzes various aspects of trading and price dynamics, such as liquidity and bid-ask spread, in an OTC spot market.

  2014.08

  PDF File

• Investment Horizon and Repo in the Over-the-Counter Market
  Hajime Tomura

  Abstract

  This paper presents a three-period model featuring a shortterm investor and dealers in an over-the-counter bond market. A short-term investor invests cash in the short term because of a need to pay cash soon. This time constraint lowers the resale price of bonds held by a short-term investor through bilateral bargaining in an over-the-counter market. Ex-ante, this hold-up problem explains the use of a repo by a short-term investor, a positive haircut due to counterparty risk, and the fragility of a repo market. This result holds without any risk to the dividends and principals of underlying bonds or asymmetric information.

  Introduction

  Many securities primarily trade in an over-the-counter (OTC) market. A notable example of such securities is bonds. The key feature of an OTC market is that the buyer and the seller in each OTC trade set the terms of trade bilaterally. There has been developed a theoretical literature analyzing the effects of this market structure on spot trading, such as Spulber (1996), Rust and Hall (2003), Duffie, Gˆarleanu, and Pedersen (2005), Miao (2006), Vayanos and Wang (2007), Lagos and Rocheteau (2010), Lagos, Rocheteau and Weill (2011), and Chiu and Koeppl (2011), for example. This literature uses search models, in which each transaction is bilateral, to analyze various aspects of trading and price dynamics, such as liquidity and bid-ask spread, in OTC spot markets.

  2013.11

  PDF File

• Repos in Over-the-Counter Markets
  Hajime Tomura

  Abstract

  This paper presents a dynamic matching model featuring dealers and short-term investors in an over-the-counter bond market. The model illustrates that bilateral bargaining in an over-the-counter market results in an endogenous bond-liquidation cost for short-term investors. This cost makes short-term investors need repurchase agreements to buy long-term bonds. The cost also explains the existence of a margin specific to repurchase agreements held by short-term investors, if repurchase agreements must be renegotiation-proof. Without repurchase agreements, short-term investors do not buy long-term bonds. In this case, the bond yield rises unless dealers have enough capital to buy and hold bonds.

  Introduction

  Repurchase agreements, or repos, are one of the primary instruments in the money market. In a repo, a short-term investor buys bonds with a future contract in which the seller of the bonds, typically a bond dealer, promises to buy back the bonds at a later date. A question arises from this observation regarding why investors need such a promise when they can simply buy and resell bonds in a series of spot transactions. In this paper, I present a model to illustrate that a bond-liquidation cost due to over-the-counter (OTC) trading can explain short-term investors’ need for repos in bond markets. It is not necessary to introduce uncertainty or asymmetric information to obtain this result.

  2013.02

  PDF File