The Interaction between Funding Liquidity and Market Liquidity: Evidence from Subprime and European Crises

Azusa Takeyama and Naoshi Tsuchida
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Azusa Takeyama: Director and Senior Economist, Institute for Monetary and Economic Studies (currently Financial System and Bank Examination Department), Bank of Japan (E-mail: azusa.takeyama@boj.or.jp)
Naoshi Tsuchida: Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: naoshi.tsuchida@boj.or.jp)

No 15-E-14, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: This paper explores the interaction between funding liquidity and market liquidity. The simultaneous reduction of funding and market liquidities is often observed during financial crises. While Brunnermeier and Pedersen (2009) argue that fragility of liquidity is due to a destabilizing effect of margin calls triggered by uninformed traders' behavior under uncertainty, Nyborg and Östberg (2014) claim that the malfunction in interbank funding markets causes declines in market liquidity in broader financial markets. We demonstrate that Nyborg and Östberg's cause was dominant during the subprime financial crisis, while both causes were valid during the European sovereign debt crisis using a structural vector autoregression model.

Keywords: Funding Liquidity; Market Liquidity; Limits of Arbitrage (search for similar items in EconPapers)
JEL-codes: G01 G14 G21 (search for similar items in EconPapers)
Date: 2015-09
New Economics Papers: this item is included in nep-ban
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Persistent link: https://EconPapers.repec.org/RePEc:ime:imedps:15-e-14

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