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The liquidity mechanics of dealer banks in the market-based credit system

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  • Becker, Christoph

Abstract

Are US government bonds (Treasuries) as good as cash? Conventional wisdom in academia and industry says that their safety and liquidity make Treasuries a cash-substitute. This paper shows that Treasuries stop being as good as cash when dealer banks face excessive liquidity risk. Using data from US money markets from July 2001–Feb 2018, I use regression analyses to examine how the liquidity risk in Treasuries and in money and bond markets more generally depends on the health of market-makers, specifically, dealer banks. I find that market-making exposes dealer banks themselves to liquidity risk, which depends on the quality of collateral in dealers' short-term credit operations. Dealer banks’ own liquidity risk is an important driver of liquidity risk in Treasuries and more broadly in money and bond markets. As a rationale for the results, I develop a mechanism how dealers manufacture liquidity in the market-based credit system.

Suggested Citation

  • Becker, Christoph, 2021. "The liquidity mechanics of dealer banks in the market-based credit system," Economic Modelling, Elsevier, vol. 105(C).
    • Handle: RePEc:eee:ecmode:v:105:y:2021:i:c:s0264999321002376
    DOI: 10.1016/j.econmod.2021.105648
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    References listed on IDEAS

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    Cited by:

    1. Ozgur, Gokcer, 2023. "The cross-border interconnectedness of shadow banking," Economic Modelling, Elsevier, vol. 126(C).

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    More about this item

    Keywords

    Treasury supply; Liquidity; Financial stability; Interest rates; Banking;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G2 - Financial Economics - - Financial Institutions and Services
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates

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