Asymmetric Information and the 2007 Financial Crisis: Evidence from the U.S. Federal Funds Market
This paper measures by how much asymmetric information increased in the U.S. federal funds market with the arrival of the 2007-09 financial crisis. This is accomplished by developing and estimating a structural model of the federal funds market, where intermediation plays a crucial role and borrowing banks differ in their unobserved probability of default. Crucially, the changes in rates of fed funds sold and purchased with the arrival of the financial crisis allows for identification. The estimates imply that the expected probability of default increased by 161 percent with the start of the crisis and this change is a main driver of the increase in the spread between fed funds purchased and sold over this time.