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|
|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: |
References listed on IDEAS
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, F. & Hoerova, M. & Holthausen, C., 2009.
"Liquidity Hoarding and Interbank Market Spreads : The Role of Counterparty Risk,"
2009-40 S, Tilburg University, Center for Economic Research.
- 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.
- Massimo Guidolin & Francesca Rinaldi, 2013. "Ambiguity in asset pricing and portfolio choice: a review of the literature," Theory and Decision, Springer, vol. 74(2), pages 183-217, February.
- Massimo Guidolin & Francesca Rinaldi, 2010. "Ambiguity in asset pricing and portfolio choice: a review of the literature," Working Papers 2010-028, Federal Reserve Bank of St. Louis.
- Massimo Guidolin & Francesca Rinaldi, 2011. "Ambiguity in Asset Pricing and Portfolio Choice: A Review of the Literature," Working Papers 417, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
- 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.