Liquidity Risk and Funding Cost

Alexander Bechtel, Angelo Ranaldo and Jan Wrampelmeyer

Review of Finance, 2023, vol. 27, issue 2, 399-422

Abstract: We propose and test a new channel that links liquidity risk and interest rates in short-term funding markets. Unlike existing theories that focus on premiums demanded by lenders, the liquidity risk channel postulates that borrowers that are more exposed to urgent liquidity needs are willing to pay a markup for immediate funding. We test and quantify the channel using unique trade-by-trade data and uncover systematic differences across individual banks’ funding cost driven by differences in banks’ liquidity risk. These differences are persistent over a decade, suggesting that the liquidity risk channel is relevant in general and not only arises during crisis times.

Keywords: Funding liquidity; Short-term interest rates; Risk premiums; Funding cost; Interbank market (search for similar items in EconPapers)
JEL-codes: D40 E43 E52 G12 G18 G21 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (4)

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Working Paper: Liquidity Risk and Funding Cost (2020)
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