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Money and Liquidity in Financial Markets

  • Kjell G. NYBORG

    (University of Zurich, Swiss Finance Institute, NHH and CEPR)

  • Per OSTBERG

    (University of Zurich, Swiss Finance Institute and NHH)

We argue that there is a connection between the interbank market for liquidity and the broader financial markets, which has its basis in demand for liquidity by banks. Tightness in the interbank market for liquidity leads banks to engage in what we term “liquidity pull-back,” which involves selling financial assets either by banks directly or by levered investors. Empirical tests support this hypothesis. While our data covers part of the recent crisis period, our results are not driven by the crisis. Our general point is that money matters in financial markets. Different financial assets have different degrees of moneyness (liquidity) and, as a result, there are systematic cross-sectional variations in trading activity as the price of liquidity, or the level of tightness, in the interbank market fluctuates.

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Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 10-25.

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Length: 57 pages
Date of creation: Nov 2009
Date of revision: Jun 2010
Handle: RePEc:chf:rpseri:rp1025
Contact details of provider: Web page: http://www.SwissFinanceInstitute.ch

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