Knightian uncertainty and interbank lending
The bursting of the housing price bubble during 2007 and 2008 was accompanied by high interbank spreads, and a partial breakdown of interbank lending. This paper theoretically models how Knightian uncertainty over banks risk exposures may have contributed to the breakdown. The paper shows: 1) the two-tier structure of the U.S. Fed Funds market makes it robust to uncertainty, but the market may nevertheless collapse — and private incentives to restart it may be insufficient. 2) In some circumstances government bank audits and information releases about exposures that resemble a stress test can restart markets and improve welfare by internalizing an externality associated with economy-wide uncertainty reduction. 3) Collapses due to uncertainty are less likely ex-ante and less costly to fix ex-post when there is better publicly available information on core banks aggregate risk exposures. Based on 2) and 3), ex-ante and ex-post “transparency initiatives” are proposed. Their success depends on the financial architecture of bank interlinkages.
|Date of creation:||2012|
|Date of revision:|
|Contact details of provider:|| Postal: 600 Atlantic Avenue, Boston, Massachusetts 02210|
Web page: http://www.bos.frb.org/
More information through EDIRC
|Order Information:|| Email: |
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Heider, Florian & Hoerova, Marie & Holthausen, Cornelia, 2009.
"Liquidity hoarding and interbank market spreads: the role of counterparty risk,"
Working Paper Series
1126, European Central Bank.
- Heider, Florian & Hoerova, Marie & Holthausen, Cornelia, 2010. "Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk," CEPR Discussion Papers 7762, C.E.P.R. Discussion Papers.
- Marie Hoerova & Cornelia Holthausen & Florian Heider, 2009. "Liquidity hoarding and interbank market spreads: the role of counterparty risk," 2009 Meeting Papers 929, Society for Economic Dynamics.
- Heider, F. & Hoerova, M. & Holthausen, C., 2009. "Liquidity Hoarding and Interbank Market Spreads : The Role of Counterparty Risk," Discussion Paper 2009-40 S, Tilburg University, Center for Economic Research.
- Adam Ashcraft & James Mcandrews & David Skeie, 2011.
"Precautionary Reserves and the Interbank Market,"
Journal of Money, Credit and Banking,
Blackwell Publishing, vol. 43, pages 311-348, October.
When requesting a correction, please mention this item's handle: RePEc:fip:fedbqu:rpa12-4. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Michal Kowalik)
If references are entirely missing, you can add them using this form.