Market Illiquidity, Credit Freezes and Endogenous Funding Constraints

Manuel Bachmann ()

No 255, Department of Economics Working Paper Series from WU Vienna University of Economics and Business

Abstract: In this paper I propose a two-step theoretical extension of the baseline model by Diamond and Rajan (2011) and examine the amplification mechanisms when collateralized funding shocks are endogenously affected by liquidity shocks. Based on high returns on illiquid assets that are potentially available conditional on future fire sales, liquid banks increase their cash holdings by limiting term lending - a speculative motive of liquidity hoarding directly aggravated by a cash reduction due to increased haircuts on collateralized borrowing. As a result, funding liquidity shrinks steadily and credit freezes are more likely. On the other hand, illiquid banks refuse to sell more illiquid assets than necessary to meet depositors' claims - a speculative motive of illiquidity seeking indirectly amplified as fire sale prices are endogenously depressed via increased collateral requirements. Illiquid banks are forced to sell more assets, the problem of insolvency becomes more severe and market freezes are thus even more likely.

Keywords: Fire Sales; Insolvency; Market & Credit Freezes; Collateralized Borrowing (search for similar items in EconPapers)
Date: 2018-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://epub.wu.ac.at/5965/ original version (application/pdf)
Our link check indicates that this URL is bad, the error code is: 403 Forbidden (https://epub.wu.ac.at/5965/ [308 PERMANENT REDIRECT]--> https://epub.wu.ac.at/id/eprint/5965 [302 FOUND]--> https://research.wu.ac.at/en/publications/65553004-3416-4e7b-8b8c-65cb31e8105b)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wiw:wus005:5965

Access Statistics for this paper

More papers in Department of Economics Working Paper Series from WU Vienna University of Economics and Business Welthandelsplatz 1, 1020 Vienna, Austria.
Bibliographic data for series maintained by WU Library ().