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Liquidity and financial cycles

Author

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  • Tobias Adrian
  • Hyun Song Shin

Abstract

In a financial system where balance sheets are continuously marked to market, asset price changes show up immediately in changes in net worth, and elicit responses from financial intermediaries, who adjust the size of their balance sheets. We document evidence that marked to market leverage is strongly procyclical. Such behaviour has aggregate consequences. Changes in aggregate balance sheets for intermediaries forecast changes in risk appetite in financial markets, as measured by the innovations in the VIX index. Aggregate liquidity can be seen as the rate of change of the aggregate balance sheet of the financial intermediaries.

Suggested Citation

  • Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and financial cycles," BIS Working Papers 256, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:256
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    References listed on IDEAS

    as
    1. Stein, Jeremy C, 1997. " Internal Capital Markets and the Competition for Corporate Resources," Journal of Finance, American Finance Association, vol. 52(1), pages 111-133, March.
    2. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross-Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, February.
    3. Gromb, Denis & Vayanos, Dimitri, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 361-407.
    4. Ayuso, Juan & Perez, Daniel & Saurina, Jesus, 2004. "Are capital buffers pro-cyclical?: Evidence from Spanish panel data," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 249-264, April.
    5. Bernanke, Ben S & Blinder, Alan S, 1988. "Credit, Money, and Aggregate Demand," American Economic Review, American Economic Association, vol. 78(2), pages 435-439, May.
    6. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    Full references (including those not matched with items on IDEAS)

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    Keywords

    financial cycle; financial intermediation; leverage; liquidity;

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