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Funding Liquidity and Market Liquidity

Yuan Yuan ()
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Yuan Yuan: Department of Economics, Temple University

No 1406, DETU Working Papers from Department of Economics, Temple University

Abstract: Recent empirical studies have shown an increasing co-movement between fund and market liquidity, which is driven by common factors such as monetary shocks. Modeling this co-movement becomes desirable to evaluate policies relating to liquidity and financial instability. This paper establishes a monetary model with capital to explain the dynamic interactions between funding and market liquidity in a search framework featured by Kiyotaki and Wright [1989]. Capital and money are two important elements here. As the collateral and production input, capital affects both fund and goods trading market. As medium of exchange, money is essential to trade; meanwhile the opportunity cost of carrying it affects the fund market imbalance as well. As a result, monetary policy can change traders' expectations and negotiations, and have non-trivial impact on fund markets and liquidity risks. Calibrated the model, simulated liquidity moments respond to monetary shocks, moving together across time and presenting business cycle properties.

Keywords: Liquidity; Monetary Policy; Search and Matching (search for similar items in EconPapers)
JEL-codes: E5 E51 E52 G12 (search for similar items in EconPapers)
Date: 2014-12
New Economics Papers: this item is included in nep-dge and nep-mac
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