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Liquidity HoardingDouglas M. GaleNew York University (NYU) - Department of Economics Tanju YorulmazerFederal Reserve Bank of New York March 1, 2011 FRB of New York Staff Report No. 488 Abstract: Banks hold liquid and illiquid assets. An illiquid bank that receives a liquidity shock sells assets to liquid banks in exchange for cash. We characterize the constrained efficient allocation as the solution to a planner’s problem and show that the market equilibrium is constrained inefficient, with too little liquidity and inefficient hoarding. Our model features a precautionary as well as a speculative motive for hoarding liquidity, but the inefficiency of liquidity provision can be traced to the incompleteness of markets (due to private information) and the increased price volatility that results from trading assets for cash.
Number of Pages in PDF File: 66 Keywords: interbank market, fire sale JEL Classification: G12, G21, G24, G32, G33, D8 working papers seriesDate posted: March 26, 2011Suggested CitationContact Information
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