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Musical chairs: a comment on the credit crisis

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  • Caballero, R J.
  • Krishnamurthy, A.

Abstract

Uncertainty –that is, a rise in unknown and immeasurable risk rather than the measurable risk that the financial sector specializes in managing– is at the heart of the recent liquidity crisis. The financial instruments and derivative structures underpinning the recent growth in credit markets are complex. Because of the rapid proliferation of these instruments, market participants cannot refer to a historical record to measure how these financial structures will behave during a time of stress. These two factors, complexity and lack of history, are the preconditions for rampant uncertainty. We explain how a rise in uncertainty can cause a liquidity crisis and discuss central bank policies in this context.

Suggested Citation

  • Caballero, R J. & Krishnamurthy, A., 2008. "Musical chairs: a comment on the credit crisis," Financial Stability Review, Banque de France, issue 11, pages 9-11, February.
    • Handle: RePEc:bfr:fisrev:2008:11:2
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    1. repec:hal:spmain:info:hdl:2441/7l10qorvrv8tuafch6e0ert238 is not listed on IDEAS
    2. James Crotty, 2009. "Structural causes of the global financial crisis: a critical assessment of the 'new financial architecture'," Cambridge Journal of Economics, Cambridge Political Economy Society, vol. 33(4), pages 563-580, July.
    3. repec:spo:wpmain:info:hdl:2441/7l10qorvrv8tuafch6e0ert238 is not listed on IDEAS
    4. Eva Liebmann & Joe Peek, 2015. "Global standards for liquidity regulation," Current Policy Perspectives 15-3, Federal Reserve Bank of Boston.
    5. William A. Brock & Charles F. Manski, 2011. "Competitive Lending with Partial Knowledge of Loan Repayment: Some Positive and Normative Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(2‐3), pages 441-459, March.
    6. E Philip Davis, 2008. "Liquidity, Financial Crises and the Lender of Last Resort – How Much of a Departure is the Sub-prime Crisis?," RBA Annual Conference Volume (Discontinued), in: Paul Bloxham & Christopher Kent (ed.),Lessons from the Financial Turmoil of 2007 and 2008, Reserve Bank of Australia.
    7. Dimitrios Koutmos & Konstantinos Bozos & Dionysia Dionysiou & Neophytos Lambertides, 2018. "The timing of new corporate debt issues and the risk-return tradeoff," Review of Quantitative Finance and Accounting, Springer, vol. 50(4), pages 943-978, May.
    8. Craig H. Furfine, 2014. "Complexity and Loan Performance: Evidence from the Securitization of Commercial Mortgages," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 2(2), pages 154-187.

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