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The price of liquidity: The effects of market conditions and bank characteristics

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  • Fecht, Falko
  • Nyborg, Kjell G.
  • Rocholl, Jörg

Abstract

We study the prices that individual banks pay for liquidity (captured by borrowing rates in repos with the central bank and benchmarked by the overnight index swap) as a function of market conditions and bank characteristics. These prices depend in particular on the distribution of liquidity across banks, which is calculated over time using individual bank-level data on reserve requirements and actual holdings. Banks pay more for liquidity when positions are more imbalanced across banks, consistent with the existence of short squeezing. We also show that small banks pay more for liquidity and are more vulnerable to squeezes. Healthier banks pay less but, contrary to what one might expect, banks in formal liquidity networks do not. State guarantees reduce the price of liquidity but do not protect against squeezes.

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  • Fecht, Falko & Nyborg, Kjell G. & Rocholl, Jörg, 2011. "The price of liquidity: The effects of market conditions and bank characteristics," Journal of Financial Economics, Elsevier, vol. 102(2), pages 344-362.
  • Handle: RePEc:eee:jfinec:v:102:y:2011:i:2:p:344-362 DOI: 10.1016/j.jfineco.2011.05.015
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    Cited by:

    1. Weber, Patrick, 2015. "Does the Eurosystem's lender of last resort facility has a structurally di fferent option value across banks?," Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 113123, Verein für Socialpolitik / German Economic Association.
    2. Acharya, Viral V. & Imbierowicz, Björn & Steffen, Sascha & Teichmann, Daniel, 2015. "Does Lack of Financial Stability Impair the Transmission of Monetary Policy?," HIT-REFINED Working Paper Series 24, Institute of Economic Research, Hitotsubashi University.
    3. Silvio Schumacher, 2016. "Networks and lending conditions: Empirical evidence from the Swiss franc money markets," Working Papers 2016-12, Swiss National Bank.
    4. Abbassi, Puriya & Nautz, Dieter, 2012. "Monetary transmission right from the start: On the information content of the Eurosystem's main refinancing operations," The North American Journal of Economics and Finance, Elsevier, vol. 23(1), pages 54-69.
    5. Craig, Ben R. & Fecht, Falko & Tümer-Alkan, Günseli, 2015. "The role of interbank relationships and liquidity needs," Journal of Banking & Finance, Elsevier, vol. 53(C), pages 99-111.
    6. Massimiliano Affinito, 2013. "Central bank refinancing, interbank markets, and the hypothesis of liquidity hoarding: evidence from a euro-area banking system," Temi di discussione (Economic working papers) 928, Bank of Italy, Economic Research and International Relations Area.
    7. Fecht, Falko & Reitz, Stefan, 2015. "Euro money market trading during times of crisis," Kiel Working Papers 2012, Kiel Institute for the World Economy (IfW).
    8. Agur, Itai, 2014. "Bank risk within and across equilibria," Journal of Banking & Finance, Elsevier, vol. 48(C), pages 322-333.
    9. Loriano Mancini & Angelo Ranaldo & Jan Wrampelmeyer, 2016. "The Euro Interbank Repo Market," Review of Financial Studies, Society for Financial Studies, vol. 29(7), pages 1747-1779.
    10. Martínez, Constanza & León, Carlos, 2016. "The cost of collateralized borrowing in the Colombian money market: Does connectedness matter?," Journal of Financial Stability, Elsevier, pages 193-205.
    11. Camba-Méndez, Gonzalo & Rodriguez-Palenzuela, Diego & Carbó-Valverde, Santiago, 2014. "Financial reputation, market interventions and debt issuance by banks: a truncated two-part model approach," Working Paper Series 1741, European Central Bank.
    12. Franklin Allen & Elena Carletti, 2013. "Financial Markets, Institutions and Liquidity," RBA Annual Conference Volume,in: Alexandra Heath & Matthew Lilley & Mark Manning (ed.), Liquidity and Funding Markets Reserve Bank of Australia.
    13. Lucas Marc Fuhrer & Basil Guggenheim & Silvio Schumacher, 2016. "Re‐Use of Collateral in the Repo Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(6), pages 1169-1193, September.
    14. Chira, Inga & Madura, Jeff & Viale, Ariel M., 2013. "Bank exposure to market fear," Journal of Financial Stability, Elsevier, vol. 9(4), pages 451-459.
    15. Xiaoqing (Maggie) Fu & Yongjia (Rebecca) Lin & Philip Molyneux, 2016. "Bank Capital And Liquidity Creation In Asia Pacific," Economic Inquiry, Western Economic Association International, vol. 54(2), pages 966-993, April.
    16. Hong, Han & Huang, Jing-Zhi & Wu, Deming, 2014. "The information content of Basel III liquidity risk measures," Journal of Financial Stability, Elsevier, vol. 15(C), pages 91-111.
    17. repec:oup:revfin:v:21:y:2017:i:1:p:33-75. is not listed on IDEAS
    18. Falk Bräuning & Falko Fecht, 2017. "Relationship Lending in the Interbank Market and the Price of Liquidity," Review of Finance, European Finance Association, vol. 21(1), pages 33-75.
    19. repec:eee:finana:v:54:y:2017:i:c:p:23-38 is not listed on IDEAS
    20. Jurgilas, Marius & Zikes, Filip, 2012. "Implicit intraday interest rate in the UK unsecured overnight money market," Bank of England working papers 447, Bank of England.
    21. Edoardo Rainone, 2017. "Pairwise trading in the money market during the European sovereign debt crisis," Temi di discussione (Economic working papers) 1160, Bank of Italy, Economic Research and International Relations Area.
    22. Brossard, Olivier & Saroyan, Susanna, 2016. "Hoarding and short-squeezing in times of crisis: Evidence from the Euro overnight money market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 40(C), pages 163-185.
    23. Heidorn, Thomas & Buschmann, Christian, 2014. "The liquidity reserve funding and management strategies," Frankfurt School - Working Paper Series 210, Frankfurt School of Finance and Management.
    24. Sarmiento, Miguel & Cely, Jorge & León, Carlos, 2017. "An early warning indicator system to monitor the unsecured interbank funds market," Research in International Business and Finance, Elsevier, vol. 40(C), pages 114-128.

    More about this item

    Keywords

    Banks; Liquidity; Money markets; Repos; Imbalance; Short squeezing; Financial health; Liquidity networks; State guarantees;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions

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