Since I recently submitted my MSc in Finance dissertation titled «The informational content of SMP deposit auctions in forecasting short-term repurchase agreement interest rates», I would like to take the opportunity to write a few words on its conclusions. The main objective of the research was to examine whether SMP deposit auctions carried valuable information for forecasting short-term repo rates. Since banks with excess liquidity always faced the choice between parking their reserves at the weekly term-deposits for a week or lending them in the GC repo market, SMP deposit rates should act as an effective floor on risk-free money market rates.
In order to evaluate the above hypothesis the paper first suggested a stochastic model for the bid rate in auctions (based mainly on the level of excess reserves in the system) as well as the conditional variance of the bid rate process (the calculation suggested that the variance was not steady but a function of excess reserves therefore implying that a possible econometric specification would face heteroskedasticity problems).
The econometric specification used a cointegrating relationship between the weekly GC and SMP deposits rate in a VEC model also containing excess bids, number of bids and the VIX index (as a proxy of market stress) as explanatory variables. A competing VAR model of the MRO and GC rate was estimated and out of sample forecasts of the GC rate for the two models were compared. The results clearly indicated that the SMP deposits did provide significant informational content for short-term money market rates.
A few people might find the (very) large section in monetary policy and repo market details informative and helpful. Overall the paper is quite technical but I hope relevant for evaluating the effectiveness of certain sterilization tools used by central banks in recent years. It might prove useful in analyzing related facilities used by the Federal Reserve (such as Interest on Reserves and the overnight and term reverse repo facilities), a topic that interests myself as well.