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Cross-Asset Holdings and the Interbank Lending Market

Olessia Caillé and Louis Raffestin

Finance, 2021, vol. 42, issue 2, 117-163

Abstract: Recent empirical papers have found that, contrary to popular belief, wholesale funding markets did not cease to function during the subprime crisis. This paper explains this resilience through the strong interconnections between banks, which give them an incentive to subsidize each other. We specify a model in which financial institutions that share similar portfolios provide each other with favorable lending conditions in order to protect themselves against fire sales. The resulting subsidy drives rates down and leads to a more clustered interbank network, particularly during crises. The subsidy is desirable from a systemic risk perspective because it helps to limit borrower risk, although it has a positive impact on the scope for contagion.

Keywords: wholesale funding; short-term unsecured lending; fire sales; systemic risk (search for similar items in EconPapers)
Date: 2021
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