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Liquidity Needs in Economies with Interconnected Financial Obligations

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  • Julio J. Rotemberg

Abstract

A model is developed where firms in a financial system have to settle their debts to each other by using a liquid asset. The question that is studied is how many firms must obtain how much of this asset from outside the financial system to make sure that all debts within the system are settled. The main result is that these liquidity needs are larger when these firms are more interconnected through their debts, i.e. when they borrow from and lend to more firms. Two pecuniary externalities are discussed. One involves the choice of paying one creditor first rather than another. The second involves the extent to which firms borrow and acquire claims on other firms with the proceeds. When a group of firms raises their involvement in this activity, firms outside the group may face more difficulties in settling their debts.

Suggested Citation

  • Julio J. Rotemberg, 2008. "Liquidity Needs in Economies with Interconnected Financial Obligations," NBER Working Papers 14222, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:14222
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    References listed on IDEAS

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    1. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, vol. 22(1), pages 1-18, January.
    2. Freixas, Xavier & Parigi, Bruno M & Rochet, Jean-Charles, 2000. "Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 611-638, August.
    3. Antoine Martin, 2005. "Recent evolution of large-value payment systems : balancing liquidity and risk," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 33-57.
    4. David L. Mengle, 1985. "Daylight overdrafts and payments system risks," Economic Review, Federal Reserve Bank of Richmond, issue May, pages 14-27.
    5. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    6. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
    7. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
    8. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2007. "Network models and financial stability," Journal of Economic Dynamics and Control, Elsevier, vol. 31(6), pages 2033-2060, June.
    9. Stacy Panigay Coleman, 2002. "The evolution of the Federal Reserve's intraday credit policies," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Feb, pages 67-84.
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    Cited by:

    1. Craig, Ben R. & Fecht, Falko & Tümer-Alkan, Günseli, 2015. "The role of interbank relationships and liquidity needs," Journal of Banking & Finance, Elsevier, vol. 53(C), pages 99-111.
    2. Maryam Farboodi, 2014. "Intermediation and Voluntary Exposure to Counterparty Risk," 2014 Meeting Papers 365, Society for Economic Dynamics.
    3. Nicola Giocoli, 2014. "Network efficiency and the banking system," International Review of Economics, Springer;Happiness Economics and Interpersonal Relations (HEIRS), vol. 61(3), pages 203-218, September.
    4. Ricardo J. Caballero, 2010. "Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome," Journal of Economic Perspectives, American Economic Association, vol. 24(4), pages 85-102, Fall.

    More about this item

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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