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The Interaction between Funding Liquidity and Market Liquidity: Evidence from Subprime and European Crises

Author

Listed:
  • Azusa Takeyama

    (Director and Senior Economist, Institute for Monetary and Economic Studies (currently Financial System and Bank Examination Department), Bank of Japan (E-mail: azusa.takeyama@boj.or.jp))

  • Naoshi Tsuchida

    (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: naoshi.tsuchida@boj.or.jp))

Abstract

This paper explores the interaction between funding liquidity and market liquidity. The simultaneous reduction of funding and market liquidities is often observed during financial crises. While Brunnermeier and Pedersen (2009) argue that fragility of liquidity is due to a destabilizing effect of margin calls triggered by uninformed traders' behavior under uncertainty, Nyborg and Östberg (2014) claim that the malfunction in interbank funding markets causes declines in market liquidity in broader financial markets. We demonstrate that Nyborg and Östberg's cause was dominant during the subprime financial crisis, while both causes were valid during the European sovereign debt crisis using a structural vector autoregression model.

Suggested Citation

  • Azusa Takeyama & Naoshi Tsuchida, 2015. "The Interaction between Funding Liquidity and Market Liquidity: Evidence from Subprime and European Crises," IMES Discussion Paper Series 15-E-14, Institute for Monetary and Economic Studies, Bank of Japan.
  • Handle: RePEc:ime:imedps:15-e-14
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    References listed on IDEAS

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    More about this item

    Keywords

    Funding Liquidity; Market Liquidity; Limits of Arbitrage;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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