One bank problem in the federal funds market

TL;DR

This paper develops a model for banks in the federal funds market to determine optimal buying and selling strategies under a contemporaneous reserve requirement regime, considering variable discount rates and asset size effects.

Contribution

It introduces a new model incorporating different discount rates for funds transactions and analyzes how asset size influences optimal strategies.

Findings

Optimal upper barrier for fund sales is linear in asset size.

Bank's net purchase amount is linear in asset size.

Model can be extended to include asset size effects.

Abstract

The model of this paper gives a convenient strategy that a bank in the federal funds market can use in order to maximize its profit in a contemporaneous reserve requirement (CRR) regime. The reserve requirements are determined by the demand deposit process, modelled as a Brownian motion with drift. We propose a new model in which the cumulative funds purchases and sales are discounted at possible different rates. We formulate and solve the problem of finding the bank's optimal strategy. The model can be extended to involve the bank's asset size and we obtain that, under some conditions, the optimal upper barrier for fund sales is a linear function of the asset size. As a consequence, the bank net purchase amount is linear in the asset size.