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Illiquidity spirals in Coupled Over-The-Counter Markets

Author

Listed:
  • Christoph Aymanns

    ()

  • Co-Pierre Georg
  • Benjamin Golub

Abstract

Banks provide intermediation of two economically coupled assets, each traded on an OTC market—e.g., secured debt and the underlying collateral. We model banks’ decisions to provide liquidity as a game of strategic complements on two coupled trading networks:incentives to be active in one network are increasing in its neighbors’ activity in both networks. When an exogenous shock renders some banks inactive, other banks follow in an illiquidity spiral across the two networks. Liquidity can be improved if one of the two OTC markets is replaced by an exchange. For a class of market structures associated with random graphs, liquidity changes discontinuously in the size of an exogenous shock, in contrast to contagion on one network.

Suggested Citation

  • Christoph Aymanns & Co-Pierre Georg & Benjamin Golub, 2017. "Illiquidity spirals in Coupled Over-The-Counter Markets," Working Papers on Finance 1810, University of St. Gallen, School of Finance.
  • Handle: RePEc:usg:sfwpfi:2018:10
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    File URL: http://ux-tauri.unisg.ch/RePEc/usg/sfwpfi/WPF-1810.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    market liquidity; funding liquidity; over-the-counter markets;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation

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