Illiquidity, insolvency, and banking regulation
This paper provides a compact framework for banking regulation analysis in the presence of uncertainty between systemic liquidity and solvency shocks. Extending the work by Cao & Illing (2009a, b), it is shown that systemic liquidity shortage arises endogenously as part of the inferior mixed strategy equilibrium. The paper compares dierent traditional regulatory policies which intend to fix the ineciencies, and argues that the co-existence of illiquidity and insolvency problems adds extra cost for banking regulation and makes some schemes that are optimal under pure illiquidity risks (such as liquidity regulation with lender of last resort policy) fail. The regulatory cost can be minimized by combining the advantages of several instruments.
|Date of creation:||Feb 2010|
|Date of revision:|
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- Patrick Bolton & Tano Santos & Jose A. Scheinkman, 2010.
"Outside And Inside Liquidity,"
1395, Princeton University, Department of Economics, Econometric Research Program..
- Acharya, Viral V., 2009.
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Journal of Financial Stability,
Elsevier, vol. 5(3), pages 224-255, September.
- 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.
- Viral Acharya & Tanju Yorulmazer, 2007.
"Cash-in-the-market pricing and optimal resolution of bank failures,"
Bank of England working papers
328, Bank of England.
- Viral V. Acharya & Tanju Yorulmazer, 2008. "Cash-in-the-Market Pricing and Optimal Resolution of Bank Failures," Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2705-2742, November.
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