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The Fragility of Short-Term Secured Funding Markets

  • Martin, Antoine
  • Skeie, David
  • Thadden, Ernst-Ludwig von

This paper develops an infinite-horizon model of financial institutions that borrow short-term and invest in long-term assets that can be traded in frictionless markets. Because these financial intermediaries perform maturity transformation, they are subject to potential runs. We derive distinct liquidity, collateral, and asset liquidation constraints, which determine whether a run can occur as a result of changing market expectations. We show that the extent to which borrowers can ward off an individual run depends on whether it has sufficient liquidity, collateral, and asset liquidation capacity. These determinants depend on the borrower’s (endogenous) balance sheet and on (exogenous) fundamentals. Systemic runs are possible if shocks to the valuation of collateral held by outside investors are sufficiently strong and uniform, and if the system as a whole is exposed to high short-term funding risk. The theory has policy implications for prudential regulation and lender-of-last-resort interventions.

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Paper provided by Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich in its series Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems with number 449.

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Date of creation: 2013
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Handle: RePEc:trf:wpaper:449
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  24. Skeie, David R., 2008. "Banking with nominal deposits and inside money," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 562-584, October.
  25. Ernst-Ludwig von Thadden & Erik Berglöf & Gérard Roland, 2010. "The Design of Corporate Debt Structure and Bankruptcy," Review of Financial Studies, Society for Financial Studies, vol. 23(7), pages 2648-2679, July.
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