Interwoven Lending, Uncertainty, and Liquidity Hoarding
Boston University - Department of Finance & Economics
March 15, 2011
Boston U. School of Management Research Paper No. 2011-13
This paper shows how uncertainties about funding in an interwoven system of intermediation can lead to excessive liquidity hoarding. In the model, funds are channeled through several financial intermediaries (banks) until they are finally invested in real assets. In case of a funding shock, banks that are uncertain about their own loans being rolled over, fear bankruptcy and cannot commit to rolling over loans they made to others either. This fear can lead local funding uncertainties to prompt banks to liquidate inefficiently large amounts of real assets without any defaults in equilibrium. The results hold even though the only source of risk aversion in the model is due to bankruptcy cost, banks are otherwise risk-neutral. The model suggests a novel explanation for the drop in lending during the Financial Crisis of 2007-2008.
Number of Pages in PDF File: 20
Keywords: financial network, interbank lending, TAF
JEL Classification: G20working papers series
Date posted: March 19, 2011 ; Last revised: March 27, 2012
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo7 in 0.406 seconds