Bank liquidity providing in a real synergy management under a cap-based valuation

Chuen-Ping Chang and Jyh-Horng Lin

Applied Economics, 2010, vol. 42, issue 24, 3161-3173

Abstract: Since banks often lend via commitments, their lending and deposit-taking may be two manifestations of one primitive function: the provision of liquidity on demand. We explore this function under a cap-based valuation. We find that (i) the strike price of the cap-based valuation increases the bank's liquid asset holdings by increasing its loan rate and loan commitment rate (with the strategic rate-adjustment complements) and decreases the bank's external finance need by increasing its deposit rate, when the bank realizes a less risky state of the world and (ii) the number of caplet days decreases the bank's liquid asset holdings by decreasing its loan rate and loan commitment rate (with the strategic rate-adjustment complements and the strategic timing substitutes) and increases the bank's external finance need by decreasing its deposit rate (with the strategic timing substitutes), when the bank realizes a more risky state. Our findings provide alternative explanations concerning the bank's liquidity function under the cap-based optimization.

Date: 2010
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DOI: 10.1080/00036840802360088

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