International College of Economics and Finance

Research Seminar

February 14 at 4.40 pm, room 3211 (Shabolovka st., 26) ICEF held the Research Seminar
Speaker: Andrei Dubovik (Netherlands Bureau for Economic Policy Analysis)

February 14 at 4.40 pm, room 3211 (Shabolovka st., 26)
Speaker: Andrei Dubovik (Netherlands Bureau for Economic Policy Analysis)
Theme: «Inside Liquidity in Competitive Markets»

Abstract: We study incentives of banks to reserve liquidity given that they can rely on the interbank market for their liquidity needs. Banks can partially pledge their assets to each other, but not to the rest of the economy. Therefore liquidity provision is endogenous. We show that if the probability of a crisis is large or if assets are slightly pledgeable, then all banks reserve liquidity. However, if the probability of a crisis is small or if assets are highly pledgeable, then banks segregate ex ante: some reserve no liquidity, others reserve to the maximum and become liquidity providers. In either equilibrium aggregate liquidity is too small if assets are not fully pledgeable. The segregation arises when holding liquidity yields increasing marginal returns in crisis states. The latter occurs when the crisis short-term rate exceeds the returns on long-term investments, because then liquidity holdings increase both the returns conditional on survival and the survival probability. Minimum liquidity requirements improve welfare if and only if the equilibrium is symmetric. A marginal central bank intervention aimed at lowering the interest rate causes a marginal crowding-out of private liquidity with public liquidity in the symmetric equilibrium, but a full crowding-out in the asymmetric equilibrium.

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