An analysis of the long-term and dynamic effects of the US money market fund reform on NIBOR

Abstract

NIBOR, the Norwegian Interbank Offered Rate, is an important reference rate for financial products in the Norwegian market. It has also become of increasing interest as conventional monetary policy tools have become less effective in influencing market rates. Furthermore, there has been an increase in the risk premium in NIBOR associated with quantitative easings in the eurozone, new Liquidity Coverage Ratio requirements and a US money market fund reform. We utilize daily data and investigate the long-term and dynamic effects of the US money market fund reform on the risk premium in NIBOR. We focus on the period from the announcement of the money market fund reform to its implementation on 23 July 2014 and 14 October 2016, respectively. We first estimate an error correction model (ECM) and analyze both long-term and short-term effects on the NIBOR risk premium. Then we expand the model into an ECM-GARCH(1,1) model, which allows for stochastic processes and time-varying volatility. We find indications of structural breaks on 23 September 2015 and 24 October 2016, respectively. The long-run estimates indicate that the reform accounts for an increase of 0.067 or 0.053 of approximately 0.4 percentage points in the risk premium and a greater effect of quantitative easings. In the short-term, there is a significant adjustment to the long-run relationship. We find mixed evidence of negative and positive short-term effects of total liquidity and market risk, respectively. We find mixed evidence of a year-end effect and a coinciding positive effect of the Liquidity Coverage Ratio requirements. The conditional variance of the first-differenced risk premium has a slowly decaying autocorrelation. The relationship between the long-run variables changes after the implementation of the reform. The subsequent decrease in the risk premium suggests that the model estimations may have underestimated the effect of the reform.