M. Suresh Sundaresan
Public Provision of Private Liquidity: Evidence from the Millennium Date Change
Coauthor(s): Zhenyu Wang.
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The Millennium Date Change (often referred to as Y2K) was anticipated to be a major
liquidity event by many financial and corporate institutions as well as the central
banks around the world. The timing of the event was foreseeable and thus satisfies
the assumptions in the economic theory on public provision of private liquidity. We
apply the theory to understand the liquidity premium in financial markets and the
actions of the U.S. central bank in the period surrounding Y2K. We demonstrate that
in the presence of this potential aggregate liquidity shock, (1) the cost of private loans
and insurance increased significantly, (2) government securities commanded a liquidity
premium, and most importantly, (3) the Fed successfully provided liquidity insurance
and reduced liquidity premium prior to Y2K by taking various actions and especially by
issuing Y2K options. These results are consistent with the predictions of the economic
theory. Our analysis links the behavior of on/off-the-run spread to the public provision
of private liquidity.
Sundaresan, M. Suresh, and Zhenyu Wang. "Public Provision of Private Liquidity: Evidence from the Millennium Date Change." Columbia Business School, September 2004.