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Banks, markets, and financial stability

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  • Eder, Armin
  • Fecht, Falko
  • Pausch, Thilo

Abstract

We use a Diamond/Dybvig-based model with two banks operating in separate regions connected by a common asset market in which banks and sophisticated depositors invest. We study the effect of a potential run (crisis) and subsequent fire sales on the asset price in both the crisis and no-crisis state. In our model, the two are jointly determined by a cash-in-the-market pricing and a no-arbitrage condition. We find that (i) a higher crisis probability increases the liquidity premium and thus asset prices in the normal and crisis case and (ii) a higher share of sophisticated investors increases market depth and thus the crisis price while it might also raise the asset price in the normal state.

Suggested Citation

  • Eder, Armin & Fecht, Falko & Pausch, Thilo, 2014. "Banks, markets, and financial stability," Discussion Papers 31/2014, Deutsche Bundesbank.
  • Handle: RePEc:zbw:bubdps:312014
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    References listed on IDEAS

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    More about this item

    Keywords

    liquidity risk; financial crises; contagion; asset price bubbles;
    All these keywords.

    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
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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