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The Effect of Regulatory Requirements and ESG Promotion on Market Liquidity

Author

Listed:
  • Peter Csoka
  • Judit Hever

    (Magyar Nemzeti Bank)

Abstract

Liquidity and market risk are key considerations in financial markets, especially in times of financial crises. For this reason, regulatory attention to and measures in these fields have been on the rise for the past years. Based on practical experience, regulations aiming at ensuring funding liquidity or, in general, reducing certain risky positions have the side effect of reducing market liquidity. To understand this effect, we extend a standard general equilibrium model with transaction costs of trading, endogenous market liquidity, and the modeling of regulation. We prove that higher regulatory requirements or divesting bad ESG assets reduces market liquidity.

Suggested Citation

  • Peter Csoka & Judit Hever, 2023. "The Effect of Regulatory Requirements and ESG Promotion on Market Liquidity," MNB Working Papers 2023/1, Magyar Nemzeti Bank (Central Bank of Hungary).
    • Handle: RePEc:mnb:wpaper:2023/1
    as

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    File URL: https://www.mnb.hu/letoltes/mnb-wp-2023-1-final.pdf
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    References listed on IDEAS

    as
    1. Csóka, Péter & Herings, P. Jean-Jacques, 2014. "Risk allocation under liquidity constraints," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 1-9.
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    3. Umut Çetin & Robert A. Jarrow & Philip Protter, 2008. "Liquidity risk and arbitrage pricing theory," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 8, pages 153-183, World Scientific Publishing Co. Pte. Ltd..
    4. Kamila Sommer & Paul Sullivan, 2018. "Implications of US Tax Policy for House Prices, Rents, and Homeownership," American Economic Review, American Economic Association, vol. 108(2), pages 241-274, February.
    5. Begenau, Juliane, 2019. "Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model," Research Papers 3554, Stanford University, Graduate School of Business.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Market liquidity; Market risk; Liquidity risk; General equilibrium model; Regulatory requirement; ESG related asset;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

    NEP fields

    This paper has been announced in the following NEP Reports:

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