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Managing liquidity: Optimal degree of centralization

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  • Pokutta, Sebastian
  • Schmaltz, Christian
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    Abstract

    Large banking groups face the question of how to optimally allocate and generate liquidity: in a central liquidity hub or in many decentralized branches. We translate this question into a facility location problem under uncertainty. We show that volatility is the key driver behind (de-)centralization. We provide an analytical solution for the 2-branch model and show that a liquidity center can be interpreted as an option on immediate liquidity. Therefore, its value can be interpreted as the price of information, i.e., the price of knowing the exact demand. Furthermore, we derive the threshold above which it is advantageous to open a liquidity center and show that it is a function of the volatility and the characteristic of the bank network. Finally, we discuss the n-branch model for real-world banking groups (10-60 branches) and show that it can be solved with high granularity (100 scenarios) within less than 30Â s.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 35 (2011)
    Issue (Month): 3 (March)
    Pages: 627-638

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    Handle: RePEc:eee:jbfina:v:35:y:2011:i:3:p:627-638

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Liquidity management Liquidity center location problem Facility location problem Real options;

    References

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    1. Nikitin, Maxim & Smith, R. Todd, 2008. "Information acquisition, coordination, and fundamentals in a financial crisis," Journal of Banking & Finance, Elsevier, vol. 32(6), pages 907-914, June.
    2. Merrouche, Ouarda & Schanz, Jochen, 2009. "Banks' intraday liquidity management during operational outages: theory and evidence from the UK payment system," Bank of England working papers 370, Bank of England.
    3. Martin, Antoine & McAndrews, James, 2010. "A study of competing designs for a liquidity-saving mechanism," Journal of Banking & Finance, Elsevier, vol. 34(8), pages 1818-1826, August.
    4. Bertsimas, Dimitris & Lauprete, Geoffrey J. & Samarov, Alexander, 2004. "Shortfall as a risk measure: properties, optimization and applications," Journal of Economic Dynamics and Control, Elsevier, vol. 28(7), pages 1353-1381, April.
    5. Christine Beijnen & Wilko Bolt, 2007. "Size matters: economies of scale in European payments processing," DNB Working Papers 155, Netherlands Central Bank, Research Department.
    6. Leonardo Bartolini & Spence Hilton & James McAndrews, 2008. "Settlement delays in the money market," Staff Reports 319, Federal Reserve Bank of New York.
    7. Spindt, Paul A & Tarhan, Vefa, 1980. "Liquidity Structure Adjustment Behavior of Large Money Center Banks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(2), pages 198-208, May.
    8. ReVelle, C. S. & Eiselt, H. A., 2005. "Location analysis: A synthesis and survey," European Journal of Operational Research, Elsevier, vol. 165(1), pages 1-19, August.
    9. Owen, Susan Hesse & Daskin, Mark S., 1998. "Strategic facility location: A review," European Journal of Operational Research, Elsevier, vol. 111(3), pages 423-447, December.
    10. Margaret L. Brandeau & Samuel S. Chiu, 1989. "An Overview of Representative Problems in Location Research," Management Science, INFORMS, vol. 35(6), pages 645-674, June.
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    Cited by:
    1. McCauley, Robert & McGuire, Patrick & von Peter, Goetz, 2012. "After the global financial crisis: From international to multinational banking?," Journal of Economics and Business, Elsevier, vol. 64(1), pages 7-23.

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