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Liquidity Needs in Economies with Interconnected Financial Obligations

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Julio J. Rotemberg

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Abstract

A model is developed where firms in a financial system have to settle their debts to each other by using a liquid asset. The question that is studied is how many firms must obtain how much of this asset from outside the financial system to make sure that all debts within the system are settled. The main result is that these liquidity needs are larger when these firms are more interconnected through their debts, i.e. when they borrow from and lend to more firms. Two pecuniary externalities are discussed. One involves the choice of paying one creditor first rather than another. The second involves the extent to which firms borrow and acquire claims on other firms with the proceeds. When a group of firms raises their involvement in this activity, firms outside the group may face more difficulties in settling their debts.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14222.

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Date of creation: Aug 2008
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Handle: RePEc:nbr:nberwo:14222

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Find related papers by JEL classification:
D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
G20 - Financial Economics - - Financial Institutions and Services - - - General

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  1. repec:fip:fedreq:y:1985:i:may:p:14-27:n:v.71no.3 is not listed on IDEAS
  2. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, vol. 22(1), pages 1-18, January. [Downloadable!] (restricted)
  3. X. Freixas & B. Parigi & J-C. Rochet, 2000. "Systemic Risk, Interbank Relations and Liquidity Provision by theCentral Bank," DNB Staff Reports (discontinued) 47, Netherlands Central Bank. [Downloadable!]
    Other versions:
  4. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Blackwell Publishing, vol. 51(3), pages 393-414, July. [Downloadable!] (restricted)
  5. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June. [Downloadable!] (restricted)
    Other versions:
  6. Stacy Panigay Coleman, 2002. "The evolution of the Federal Reserve's intraday credit policies," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Feb, pages 67-84. [Downloadable!]
  7. Antoine Martin, 2005. "Recent evolution of large-value payment systems : balancing liquidity and risk," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 33-57. [Downloadable!]
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