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Liquidity backstops and dynamic debt runs

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  • Wei, Bin
  • Yue, Vivian Z.

Abstract

Liquidity backstops can mitigate runs. In this paper we develop a dynamic model of debt runs based on He and Xiong (2012) to identify, both conceptually and quantitatively, the value of a liquidity backstop for its run-mitigating role. For the purpose of identification, we focus on the municipal bond markets for variable rate demand obligations and auction rate securities. Based on the run episodes in these markets during the financial crisis of 2007-09 and the calibrated model, we find that the value of a liquidity backstop is about 14.5 basis points per annum. Our findings have important policy implications regarding the effectiveness of liquidity backstops in ameliorating problems of financial instability.

Suggested Citation

  • Wei, Bin & Yue, Vivian Z., 2020. "Liquidity backstops and dynamic debt runs," Journal of Economic Dynamics and Control, Elsevier, vol. 116(C).
    • Handle: RePEc:eee:dyncon:v:116:y:2020:i:c:s0165188920300841
    DOI: 10.1016/j.jedc.2020.103916
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    1. repec:fip:a00001:88075 is not listed on IDEAS
    2. Wei, Bin & Yue, Vivian Z., 2020. "Liquidity backstops and dynamic debt runs," Journal of Economic Dynamics and Control, Elsevier, vol. 116(C).
    3. Darko B. Vukovic & Carlos J. Rincon & Moinak Maiti, 2021. "Price distortions and municipal bonds premiums: evidence from Switzerland," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 7(1), pages 1-21, December.
    4. Bordo, Michael D. & Duca, John V., 2023. "How the new fed municipal bond facility capped municipal-treasury yield spreads in the Covid-19 recession," Journal of the Japanese and International Economies, Elsevier, vol. 67(C).

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    More about this item

    Keywords

    Liquidity backstop; Debt run; Lender of last resort;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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