Money and Liquidity in Financial Markets
Kjell G. Nyborg
University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); Swiss Finance Institute
University of Zurich - Department of Banking and Finance; Swiss Finance Institute
CEPR Discussion Paper No. DP7905
We argue that there is a connection between the interbank market for liquidity and the broader financial markets, which has its basis in demand for liquidity by banks. Tightness in the interbank market for liquidity leads banks to engage in what we term "liquidity pull-back," which involves selling financial assets either by banks directly or by levered investors. Empirical tests support this hypothesis. While our data covers part of the recent crisis period, our results are not driven by the crisis. Our general point is that money matters in financial markets. Different financial assets have different degrees of moneyness (liquidity) and, as a result, there are systematic cross-sectional variations in trading activity as the price of liquidity, or the level of tightness, in the interbank market fluctuates.
Number of Pages in PDF File: 55
Keywords: interbank and financial markets, liquidity, liquidity pull-back, money
JEL Classification: E41, E44, E51, G12, G21working papers series
Date posted: July 19, 2010
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