A Model of Liquidity Hoarding and Term Premia in Inter-Bank Markets

Viral Acharya and David Skeie

No 8705, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Financial crises are associated with reduced volumes and extreme levels of rates for term inter-bank transactions, such as in one-month and three-month LIBOR markets. We provide an explanation of such stress in term lending by modelling leveraged banks? precautionary demand for liquidity. When adverse asset shocks materialize, a bank?s ability to roll over debt is impaired because of agency problems associated with high leverage. In turn, a bank?s propensity to hoard liquidity is increasing, or conversely its willingness to provide term lending is decreasing, in its rollover risk over the term of the loan. High levels of short-term leverage and illiquidity of assets can thus lead to low volumes and high rates for term borrowing, even for banks with profitable lending opportunities. In extremis, there can be a complete freeze in inter-bank markets.

Keywords: Interbank market; Bank liquidity; Financial leverage; Risk management; Debt; Bank loans (search for similar items in EconPapers)
JEL-codes: E43 G01 G21 (search for similar items in EconPapers)
Date: 2011-12
New Economics Papers: this item is included in nep-ban, nep-bec, nep-cba, nep-mac and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (192)

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Journal Article: A model of liquidity hoarding and term premia in inter-bank markets (2011)
Working Paper: A model of liquidity hoarding and term premia in inter-bank markets (2011)
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