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Liquidity Hoarding

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  • Douglas Gale

    ()

  • Tanju Yorulmazer

    ()

Abstract

Banks hold liquid and illiquid assets. An illiquid bank that receives a liquidity shock sells assets to liquid banks in exchange for cash. We characterize the constrained efficient allocation as the solution to a planners problem and show that the market equilibrium is constrained inefficient, with too little liquidity and inefficient hoarding. Our model features a precautionary as well as a speculative motive for hoarding liquidity, but the inefficiency of liquidity provision can be traced to the incompleteness of markets (due to private information) and the increased price volatility that results from trading assets for cash.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/DP682%20AXA7.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp682.

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Date of creation: Jun 2011
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Handle: RePEc:fmg:fmgdps:dp682

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  1. Paul Goldsmith-Pinkham & Tanju Yorulmazer, 2010. "Liquidity, Bank Runs, and Bailouts: Spillover Effects During the Northern Rock Episode," Journal of Financial Services Research, Springer, vol. 37(2), pages 83-98, June.
  2. Douglas W. Diamond & Raghuram G. Rajan, 2002. "Liquidity Shortages and Banking Crises," NBER Working Papers 8937, National Bureau of Economic Research, Inc.
  3. Viral V. Acharya & Ouarda Merrouche, 2010. "Precautionary Hoarding of Liquidity and Inter-Bank Markets: Evidence from the Sub-prime Crisis," NBER Working Papers 16395, National Bureau of Economic Research, Inc.
  4. Gary Gorton & Lixin Huang, 2002. "Liquidity, Efficiency and Bank Bailouts," NBER Working Papers 9158, National Bureau of Economic Research, Inc.
  5. Acharya, Viral V. & Gale, Douglas M & Yorulmazer, Tanju, 2009. "Rollover Risk and Market Freezes," CEPR Discussion Papers 7122, C.E.P.R. Discussion Papers.
  6. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, 08.
  7. Huang, Rocco & Ratnovski, Lev, 2011. "The dark side of bank wholesale funding," Journal of Financial Intermediation, Elsevier, vol. 20(2), pages 248-263, April.
  8. Lagos, Ricardo & Rocheteau, Guillaume & Weill, Pierre-Olivier, 2011. "Crises and liquidity in over-the-counter markets," Journal of Economic Theory, Elsevier, vol. 146(6), pages 2169-2205.
  9. Markus K. Brunnermeier & Martin Oehmke, 2013. "The Maturity Rat Race," Journal of Finance, American Finance Association, vol. 68(2), pages 483-521, 04.
  10. Gary Gorton & Andrew Metrick, 2010. "Securitized Banking and the Run on Repo," NBER Chapters, in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
  11. Franklin Allen & Douglas Gale, 2003. "Financial Intermediaries and Markets," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 00-44, Wharton School Center for Financial Institutions, University of Pennsylvania.
  12. David Easley & Maureen O'Hara, 2009. "Ambiguity and Nonparticipation: The Role of Regulation," Review of Financial Studies, Society for Financial Studies, vol. 22(5), pages 1817-1843, May.
  13. Acharya, Viral V & Skeie, David, 2011. "A Model of Liquidity Hoarding and Term Premia in Inter-Bank Markets," CEPR Discussion Papers 8705, C.E.P.R. Discussion Papers.
  14. Franklin Allen & Douglas Gale, 2005. "From Cash-in-the-Market Pricing to Financial Fragility," Journal of the European Economic Association, MIT Press, MIT Press, vol. 3(2-3), pages 535-546, 04/05.
  15. Frédéric Malherbe, 2010. "Self-fulfilling liquidity dry-ups," Working Paper Research, National Bank of Belgium 185, National Bank of Belgium.
  16. Viral V. Acharya & Hyun Song Shin & Tanju Yorulmazer, 2009. "Crisis Resolution and Bank Liquidity," NBER Working Papers 15567, National Bureau of Economic Research, Inc.
  17. Gara Afonso & Anna Kovner & Antoinette Schoar, 2010. "Stressed, not frozen: the Federal Funds market in the financial crisis," Staff Reports 437, Federal Reserve Bank of New York.
  18. Brunnermeier, Markus K & Pedersen, Lasse Heje, 2007. "Market Liquidity and Funding Liquidity," CEPR Discussion Papers 6179, C.E.P.R. Discussion Papers.
  19. Acharya, Viral V & Gromb, Denis & Yorulmazer, Tanju, 2008. "Imperfect Competition in the Inter-Bank Market for Liquidity as a Rationale for Central Banking," CEPR Discussion Papers 6984, C.E.P.R. Discussion Papers.
  20. Hyun Song Shin, 2009. "Reflections on Northern Rock: The Bank Run That Heralded the Global Financial Crisis," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 101-19, Winter.
  21. Heider, F. & Hoerova, M. & Holthausen, C., 2009. "Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk," Discussion Paper, Tilburg University, Center for Economic Research 2009-40 S, Tilburg University, Center for Economic Research.
  22. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
  23. Gara Afonso & Anna Kovner & Antoinette Schoar, 2010. "Stressed not Frozen: The Fed Funds Market in the Financial Crisis," NBER Working Papers 15806, National Bureau of Economic Research, Inc.
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  25. Easley, David & O'Hara, Maureen, 2010. "Liquidity and valuation in an uncertain world," Journal of Financial Economics, Elsevier, vol. 97(1), pages 1-11, July.
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Citations

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Cited by:
  1. Merrouche, Ouarda & Nier, Erlend, 2010. "Payment systems, inside money and financial intermediation," Policy Research Working Paper Series 5445, The World Bank.
  2. Fecht, Falko & Eder, Armin & Pausch, Thilo, 2013. "Banks, Markets, and Financial Stability," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79712, Verein für Socialpolitik / German Economic Association.
  3. Acharya, Viral V & Skeie, David, 2011. "A Model of Liquidity Hoarding and Term Premia in Inter-Bank Markets," CEPR Discussion Papers 8705, C.E.P.R. Discussion Papers.
  4. Leo de Haan & Jan Willem van den End, 2011. "Banks' responses to funding liquidity shocks: lending adjustment, liquidity hoarding and fire sales," DNB Working Papers, Netherlands Central Bank, Research Department 293, Netherlands Central Bank, Research Department.
  5. Acharya, Viral V & Viswanathan, S, 2008. "Moral Hazard, Collateral and Liquidity," CEPR Discussion Papers 6630, C.E.P.R. Discussion Papers.
  6. Lena Tonzer, 2013. "Cross-Border Interbank Networks, Banking Risk and Contagion," FIW Working Paper series 129, FIW.
  7. Nikolaou, Kleopatra, 2009. "Liquidity (risk) concepts: definitions and interactions," Working Paper Series 1008, European Central Bank.
  8. Jimenez Porras, G. & Ongena, S. & Peydro, J.L. & Saurina, J., 2012. "Credit Supply versus Demand: Bank and Firm Balance-Sheet Channels in Good and Crisis Times," Discussion Paper, Tilburg University, Center for Economic Research 2012-005, Tilburg University, Center for Economic Research.
  9. Filipović, Damir & Trolle, Anders B., 2013. "The term structure of interbank risk," Journal of Financial Economics, Elsevier, vol. 109(3), pages 707-733.

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