Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk

F. Heider; M. Hoerova; C. Holthausen

Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk

F. Heider
, M. Hoerova
, C. Holthausen

Finance

Research output: Working paper › Discussion paper › Other research output

Abstract

We study the functioning and possible breakdown of the interbank market due to asymmetric information about counterparty risk. We allow for privately observed shocks to the distribution of asset risk across banks after the initial portfolio of liquid and illiquid investments is chosen. Our model generates sev- eral interbank market regimes: 1) low interest rate spread and full participation; 2) elevated spread and adverse selection; and 3) liquidity hoarding leading to a market breakdown. The regimes are in line with observed developments in the interbank market before and during the 2007-09 financial crisis. We use the model to examine various policy responses.

Original language	English
Place of Publication	Tilburg
Publisher	EBC
Number of pages	43
Volume	2009-11 S
Publication status	Published - 2009

Publication series

Name	EBC Discussion Paper
Volume	2009-11 S

UN SDGs

This output contributes to the following UN Sustainable Development Goals (SDGs)

SDG 1 No Poverty
SDG 8 Decent Work and Economic Growth
SDG 10 Reduced Inequalities

Keywords

Financial crisis
Interbank market
Liquidity
Asymmetric in- formation

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Cite this

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title = "Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk",

abstract = "We study the functioning and possible breakdown of the interbank market due to asymmetric information about counterparty risk. We allow for privately observed shocks to the distribution of asset risk across banks after the initial portfolio of liquid and illiquid investments is chosen. Our model generates sev- eral interbank market regimes: 1) low interest rate spread and full participation; 2) elevated spread and adverse selection; and 3) liquidity hoarding leading to a market breakdown. The regimes are in line with observed developments in the interbank market before and during the 2007-09 financial crisis. We use the model to examine various policy responses.",

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AU - Hoerova, M.

AU - Holthausen, C.

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PY - 2009

Y1 - 2009

N2 - We study the functioning and possible breakdown of the interbank market due to asymmetric information about counterparty risk. We allow for privately observed shocks to the distribution of asset risk across banks after the initial portfolio of liquid and illiquid investments is chosen. Our model generates sev- eral interbank market regimes: 1) low interest rate spread and full participation; 2) elevated spread and adverse selection; and 3) liquidity hoarding leading to a market breakdown. The regimes are in line with observed developments in the interbank market before and during the 2007-09 financial crisis. We use the model to examine various policy responses.

AB - We study the functioning and possible breakdown of the interbank market due to asymmetric information about counterparty risk. We allow for privately observed shocks to the distribution of asset risk across banks after the initial portfolio of liquid and illiquid investments is chosen. Our model generates sev- eral interbank market regimes: 1) low interest rate spread and full participation; 2) elevated spread and adverse selection; and 3) liquidity hoarding leading to a market breakdown. The regimes are in line with observed developments in the interbank market before and during the 2007-09 financial crisis. We use the model to examine various policy responses.

KW - Financial crisis

KW - Interbank market

KW - Liquidity

KW - Asymmetric in- formation

M3 - Discussion paper

VL - 2009-11 S

T3 - EBC Discussion Paper

BT - Liquidity Hoarding and Interbank Market Spreads

PB - EBC

CY - Tilburg

ER -

Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk

Abstract

Publication series

UN SDGs

Keywords

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