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Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation

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  • Douglas Davis
  • Oleg Korenok
  • John Lightle
  • Edward Simpson Prescott

Abstract

We develop a stylized interbank market environment and use it to evaluate with experimental methods the effects of liquidity requirements. Baseline and liquidity-regulated regimes are analyzed in a simple shock environment, which features a single idiosyncratic shock, and in a compound shock environment, in which the idiosyncratic shock is followed by a randomly occurring second-stage shock. Interbank trading of the illiquid asset follows each shock. In the simple shock environment, we find that liquidity regulations reduce the incidence of bankruptcies, but at a large loss of investment efficiency. In the compound shock environment, liquidity regulations not only impose a loss of investment efficiency but also fail to reduce bankruptcies.

Suggested Citation

  • Douglas Davis & Oleg Korenok & John Lightle & Edward Simpson Prescott, 2018. "Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation," Working Papers (Old Series) 1810, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwp:1810
    DOI: 10.26509/frbc-wp-201810
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    Cited by:

    1. Hubert J. Kiss & Ismael Rodriguez-Lara & Alfonso Rosa-Garcia, 2022. "Experimental bank runs," Chapters, in: Sascha Füllbrunn & Ernan Haruvy (ed.), Handbook of Experimental Finance, chapter 25, pages 347-361, Edward Elgar Publishing.
      • Hubert J. Kiss & Ismael Rodriguez-Lara & Alfonso Rosa-Garcia, 2021. "Experimental Bank Runs," ThE Papers 21/03, Department of Economic Theory and Economic History of the University of Granada..
    2. Cox, Caleb & Davis, Douglas & Korenok, Oleg & Lightle, John, 2023. "Stress tests and information disclosure: An experimental analysis," Journal of Banking & Finance, Elsevier, vol. 154(C).

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    More about this item

    Keywords

    Interbank market; liquidity regulations; market experiments;
    All these keywords.

    JEL classification:

    • C9 - Mathematical and Quantitative Methods - - Design of Experiments
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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