Post by Sapphire Capital on Aug 21, 2008 23:08:47 GMT 4
Endogenous Systemic Liquidity Risk
Jin Cao
Munich Graduate School of Economics, Ludwig Maximilians University of Munich
Gerhard Illing
Ludwig Maximilians University of Munich - Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
July 2008
CFS Working Paper 2008/23
Abstract:
Traditionally, aggregate liquidity shocks are modelled as exogenous events. Extending our previous work (Cao & Illing, 2007), this paper analyses the adequate policy response to endogenous systemic liquidity risk. We analyse the feedback between lender of last resort policy and incentives of private banks, determining the aggregate amount of liquidity available. We show that imposing minimum liquidity standards for banks ex ante are a crucial requirement for sensible lender of last resort policy. In addition, we analyse the impact of equity requirements and narrow banking, in the sense that banks are required to hold sufficient liquid funds so as to pay out in all contingencies. We show that such a policy is strictly inferior to imposing minimum liquidity standards ex ante combined with lender of last resort policy.
papers.ssrn.com/sol3/papers.cfm?abstract_id=1191722
Jin Cao
Munich Graduate School of Economics, Ludwig Maximilians University of Munich
Gerhard Illing
Ludwig Maximilians University of Munich - Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
July 2008
CFS Working Paper 2008/23
Abstract:
Traditionally, aggregate liquidity shocks are modelled as exogenous events. Extending our previous work (Cao & Illing, 2007), this paper analyses the adequate policy response to endogenous systemic liquidity risk. We analyse the feedback between lender of last resort policy and incentives of private banks, determining the aggregate amount of liquidity available. We show that imposing minimum liquidity standards for banks ex ante are a crucial requirement for sensible lender of last resort policy. In addition, we analyse the impact of equity requirements and narrow banking, in the sense that banks are required to hold sufficient liquid funds so as to pay out in all contingencies. We show that such a policy is strictly inferior to imposing minimum liquidity standards ex ante combined with lender of last resort policy.
papers.ssrn.com/sol3/papers.cfm?abstract_id=1191722