Asset Illiquidity and Dynamic Bank Capital Requirements

Hajime Tomura

International Journal of Central Banking, 2014, vol. 10, issue 3, 1-47

Abstract: This paper introduces banks into a dynamic stochastic general equilibrium model by featuring asymmetric information as the underlying friction for banking. Asymmetric information about asset qualities causes a lemons problem in the asset market. In this environment, banks can issue liquid liabilities by pooling illiquid assets contaminated by asymmetric information. The liquidity transformation by banks results in a minimum value of common equity that banks must issue to avoid a run. This value increases with downside risk to the asset price and the expected degree of asset illiquidity. It rises during a boom if productivity shocks cause the business cycle.

JEL-codes: D82 E44 G21 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (6)

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