Regulation of Systemic Liquidity Risk
The paper provides a baseline model for regulatory analysis of systemic liquidity shocks. We show that banks may have an incentive to invest excessively in illiquid long term projects. In the prevailing mixed strategy equilibrium the allocation is inferior from the investor’s point of view since some banks free-ride on the liquidity provision as a result of limited liability. The paper compares different regulatory mechanisms to cope with the externalities. It is shown that the combination of liquidity regulation ex ante and lender of last resort policy ex post is able to implement the outcome maximizing investor’s payoff. In contrast, both “narrow banking” and imposing equity requirements as buffer are inferior mechanisms for coping with systemic liquidity risk.
|Date of creation:||Jan 2010|
|Date of revision:|
|Contact details of provider:|| Postal: Ludwigstr. 28, 80539 Munich, Germany|
Web page: http://www.vwl.uni-muenchen.de
More information through EDIRC
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.:
- Franklin Allen & Douglas Gale, 1976.
"Optimal Financial Crises,"
Center for Financial Institutions Working Papers
97-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
- Holmstrom, B & Tirole, J, 1996.
"Private and Public Supply of Liquidity,"
96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
- Diamond, Douglas W & Dybvig, Philip H, 1983.
"Bank Runs, Deposit Insurance, and Liquidity,"
Journal of Political Economy,
University of Chicago Press, vol. 91(3), pages 401-19, June.
- Acharya, Viral V, 2009.
"A Theory of Systemic Risk and Design of Prudential Bank Regulation,"
CEPR Discussion Papers
7164, C.E.P.R. Discussion Papers.
- Acharya, Viral V., 2009. "A theory of systemic risk and design of prudential bank regulation," Journal of Financial Stability, Elsevier, vol. 5(3), pages 224-255, September.
- Gersbach, Hans, 2009. "Private Insurance Against Systemic Crises?," CEPR Discussion Papers 7342, C.E.P.R. Discussion Papers.
- Douglas W. Diamond & Raghuram G. Rajan, 2006.
"Money in a Theory of Banking,"
American Economic Review,
American Economic Association, vol. 96(1), pages 30-53, March.
- Wolf Wagner, 2009. "Efficient Asset Allocations in the Banking Sector and Financial Regulation," International Journal of Central Banking, International Journal of Central Banking, vol. 5(1), pages 75-95, March.
When requesting a correction, please mention this item's handle: RePEc:lmu:muenec:11306. 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: (Tamilla Benkelberg)
If references are entirely missing, you can add them using this form.