Endogenous Systemic Liquidity Risk

Jin Cao () and Gerhard Illing

Discussion Papers in Economics from University of Munich, Department of Economics

Abstract: Traditionally, aggregate liquidity shocks are modelled as exogenous events. Extending our previous work (Cao & Illing, 2007), this paper analyses the adequate policy response to endogenous systemic liquidity risk. We analyse the feedback between lender of last resort policy and incentives of private banks, determining the aggregate amount of liquidity available. We show that imposing minimum liquidity standards for banks ex ante are a crucial requirement for sensible lender of last resort policy. In addition, we analyse the impact of equity requirements and narrow banking, in the sense that banks are required to hold sufficient liquid funds so as to pay out in all contingencies. We show that such a policy is strictly inferior to imposing minimum liquidity standards ex ante combined with lender of last resort policy.

Keywords: Liquidity risk; Free-riding; Narrow banking; Lender of last resort (search for similar items in EconPapers)
JEL-codes: E5 G21 G28 (search for similar items in EconPapers)
Date: 2008-04-21
New Economics Papers: this item is included in nep-cta, nep-fmk, nep-mac and nep-rmg
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Endogenous Systemic Liquidity Risk (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:lmu:muenec:3358

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