Posted Content•
Liquidity, Moral Hazard and Inter-Bank Market Collapse
TL;DR: In this article, the authors proposed a framework to analyze the functioning of the interbank liquidity market and the occurrence of liquidity crises, which relies on three key assumptions: (i) liquidity provisioning is not verifiable -it cannot be contracted upon-, (ii) banks face moral hazard when confronted with liquidity shocks-unobservable effort can help overcome the shock, and (iii) liquidity shocks are private information - they cannot be diversified away.
Abstract: This paper proposes a framework to analyze the functioning of the inter-bank liquidity market and the occurrence of liquidity crises. The model relies on three key assumptions: (i) liquidity provisioning is not verifiable -it cannot be contracted upon-, (ii) banks face moral hazard when confronted with liquidity shocks-unobservable effort can help overcome the shock-, (iii) liquidity shocks are private information - they cannot be diversified away-. Under these assumptions, the equilibrium risk-adjusted return on liquidity provisioning increases with the aggregate equilibrium volume of ex ante liquidity provision. As a consequence, banks may provision too little liquidity compared with the social optimum. Within this framework we derive two main results. First inter-bank market collapse is an equilibrium. Second such an equilibrium is more likely when (i) the individual probability of the liquidity shock is lower, (ii) ex ante competition between banks on illiquid long term assets is larger.
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TL;DR: The American Journal of Law & Medicine has been tracking and contributing to the development of health law since its inception at Boston University School of Law in 1975.
Abstract: The American Journal of Law & Medicine has been tracking and contributing to the development of health law since its inception at Boston University School of Law in 1975. The Journal publishes articles authored by professors, attorneys, physicians, and other health care professionals on subjects ranging from health law and policy to the legal, ethical, and economic aspects of medical practice, research, and education.
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Book•
24 Sep 2012TL;DR: In this paper, the authors proposed a framework to analyze the functioning of the interbank liquidity market and the occurrence of liquidity crises, which relies on three key assumptions: (i) liquidity provisioning is not verifiable -it cannot be contracted upon-, (ii) banks face moral hazard when confronted with liquidity shocks -unobservable effort can help overcome the shock, and (iii) liquidity shocks are private information - they cannot be diversified away.
Abstract: This paper proposes a framework to analyze the functioning of the inter-bank liquidity market and the occurrence of liquidity crises. The model relies on three key assumptions: (i) liquidity provisioning is not verifiable -it cannot be contracted upon-, (ii) banks face moral hazard when confronted with liquidity shocks -unobservable effort can help overcome the shock-, (iii) liquidity shocks are private information - they cannot be diversified away-. Under these assumptions, the equilibrium risk-adjusted return on liquidity provisioning is shown to increase with the aggregate equilibrium volume of ex ante liquidity provision. As a consequence, banks may provision too little liquidity compared with the social optimum. Within this framework we derive two main results. First inter-bank market collapse is an equilibrium. Second such an equilibrium is more likely when (i) the individual probability of the liquidity shock is lower, (ii) ex ante competition between banks on illiquid long term assets is larger.
1 citations
Journal Article•
TL;DR: In this article, the authors present a dynamic stochastic general equilibrium model which studies the business-cycle implications of financial frictions and liquidity risk at the bank-level, which induces a credit crunch scenario which shares key features with the Great Recession such as strong output decline, procyclical leverage and countercyclical liquidity hoarding.
Abstract: This paper presents a dynamic stochastic general equilibrium model which studies the business-cycle implications of financial frictions and liquidity risk at the bank-level. Following Holmstrom and Tirole (1998), demand for liquidity reserves arises from the anticipation of idiosyncratic operating expenses during the execution phase of bank-financed investment projects. Banks react to adverse aggregate shocks by hoarding liquidity while being forced to decrease their leverage. Both eects amplify recessionary dynamics, since they crowd out funds available for investment financing. This mechanism is triggered by a market liquidity squeeze modelled as a shock to the collateral value of banks’ assets. This novel type of aggregate risk induces a credit crunch scenario which shares key features with the Great Recession such as strong output decline, pro-cyclical leverage and counter-cyclical liquidity hoarding. Unconventional credit policy in the form of a wealth transfer from households to credit constrained banks is shown to mitigate the credit crunch.
1 citations
Dissertation•
18 Apr 2013