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Endogenous Liquidity Supply

Author

Listed:
  • Wilbur John Coleman II

    (Duke University)

  • Christian T. Lundblad

    (Univ of North Carolina, Chapel hill)

  • Ravi Bansal

    (Duke University)

Abstract

We present a general equilibrium model to understand the implications of short-term debt playing a special role in an economy in providing liquidity and facilitating transactions. In our model the supplies of short-term public and private debt are an endogenous outcome of optimal actions by the treasury and private financial intermediaries. Our model leads to the following three predictions. (1) A higher supply of public debt leads to a lower liquidity premium on treasuries, which tends to raise its pecuniary return (i.e., risk free rate). (2) A higher supply of public debt leads to a lower supply of private debt as private financial intermediaries compete with government debt in providing liquidity services. (3) A rise in aggregate uncertainty leads to a fall in private sector debt and a rise in public debt. Using data from 1950 to 2009 we find strong empirical support for all these predictions. In all, our model helps understand fluctuations in the availability of short-term private and public debt in a changing macro-economic environment.

Suggested Citation

  • Wilbur John Coleman II & Christian T. Lundblad & Ravi Bansal, 2011. "Endogenous Liquidity Supply," 2011 Meeting Papers 1200, Society for Economic Dynamics.
    • Handle: RePEc:red:sed011:1200
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    Cited by:

    1. Rosen Valchev, 2020. "Bond Convenience Yields and Exchange Rate Dynamics," American Economic Journal: Macroeconomics, American Economic Association, vol. 12(2), pages 124-166, April.
    2. Hong-Yi Chen & Cheng Few Lee & Tzu Tai, 2020. "The Joint Determinants of Capital Structure and Stock Rate of Return: A LISREL Model Approach," World Scientific Book Chapters, in: Cheng Few Lee & John C Lee (ed.), HANDBOOK OF FINANCIAL ECONOMETRICS, MATHEMATICS, STATISTICS, AND MACHINE LEARNING, chapter 35, pages 1345-1397, World Scientific Publishing Co. Pte. Ltd..
    3. He, Zhiguo & Nagel, Stefan & Song, Zhaogang, 2022. "Treasury inconvenience yields during the COVID-19 crisis," Journal of Financial Economics, Elsevier, vol. 143(1), pages 57-79.
    4. Graham, John R. & Leary, Mark T. & Roberts, Michael R., 2015. "A century of capital structure: The leveraging of corporate America," Journal of Financial Economics, Elsevier, vol. 118(3), pages 658-683.
    5. John R. Graham & Mark T. Leary & Michael R. Roberts, 2013. "A Century of Capital Structure: The Leveraging of Corporate America," NBER Chapters, in: New Perspectives on Corporate Capital Structure, National Bureau of Economic Research, Inc.

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