Banks' Advantage in Hedging Liquidity Risk: Theory and Evidence from the Commercial Paper Market

Evan Gatev and Philip E. Strahan

No 9956, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper argues that banks have a unique ability to hedge against market-wide liquidity shocks. Deposit inflows provide funding for loan demand shocks that follow declines in market liquidity. Consequently, one dimension of bank specialness' is that banks can insure firms against systematic declines in market liquidity at lower cost than other financial institutions. We provide supporting empirical evidence from the commercial paper (CP) market. When market liquidity dries up and CP spreads increase, banks experience funding inflows. These flows allow banks to meet increased loan demand from borrowers drawing funds from pre-existing commercial paper backup lines, without running down their holdings of liquid assets. Moreover, the supply of cheap funds is sufficiently large so that pricing on new lines of credit actually falls as market spreads widen.

JEL-codes: G2 (search for similar items in EconPapers)
Date: 2003-09
New Economics Papers: this item is included in nep-fin
Note: CF
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

Published as Gatev, Evan and Philip E. Strahan. "Banks' Advantage In Hedging Liquidity Risk: Theory and Evidence From The Commercial Paper Market," Journal of Finance, 2006, v61(2,Apr), 867-892.

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