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Money and Liquidity in Financial Markets

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  • Kjell G. NYBORG

    (University of Zurich, Swiss Finance Institute, NHH and CEPR)

  • Per OSTBERG

    (University of Zurich, Swiss Finance Institute and NHH)

Abstract

We argue that there is a connection between the interbank market for liquidity and the broader financial markets, which has its basis in demand for liquidity by banks. Tightness in the interbank market for liquidity leads banks to engage in what we term “liquidity pull-back,” which involves selling financial assets either by banks directly or by levered investors. Empirical tests support this hypothesis. While our data covers part of the recent crisis period, our results are not driven by the crisis. Our general point is that money matters in financial markets. Different financial assets have different degrees of moneyness (liquidity) and, as a result, there are systematic cross-sectional variations in trading activity as the price of liquidity, or the level of tightness, in the interbank market fluctuates.

Suggested Citation

  • Kjell G. NYBORG & Per OSTBERG, 2010. "Money and Liquidity in Financial Markets," Swiss Finance Institute Research Paper Series 10-25, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1025
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    More about this item

    Keywords

    money; liquidity; interbank and financial markets; liquidity pull-back;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers

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