Relation Between Interest Rate Difference and Trading Volume Difference in Chinese Inter-Bank Money Market

Inter-bank offerings (IBO) and repos are popular short-term transactions in Chinese inter-bank market. It is found that the difference of the interest rates is negatively correlated with the difference of trading volumes between IBO and repo with the same maturity. By examining the conditional expectation and variance using joint conditional density of the interest rate difference and the trading volume difference estimated by the SNP, the trading volume difference is found capable of explaining the expected difference of interest rates, which is consistent with the pricing theory that illiquidity is rewarded by higher expected return. The trading volume difference can also explain the volatility of the interest rate difference, indicating that liquidity shares the cause of market fluctuation. Moreover, the analysis confirms the influence of the interest rate difference on the investors´ behaviors by showing that larger interest rate difference will relatively enlarge the subsequent trading volume difference, which also illuminates that the inter-bank money market is still dominated by the money lenders as a whole.