Abstract

http://ssrn.com/abstract=7325
 


 



On the Efficiency of Cash Settlement


Charles M. Kahn


University of Illinois, Urbana-Champaign

William Roberds


Federal Reserve Bank of Atlanta

November 1995

WP 95-11

Abstract:     
This paper investigates the question of why banks almost always settle payments in cash as opposed to debt. Our model suggests that adverse selection with respect to the quality of bank assets may be the primary motivation underlying this practice. Banks with higher-quality assets prefer not to exchange debt with other banks if their debt is indistinguishable from that of banks with lower-quality assets. Banks with higher-quality assets prefer to sell off assets to informed outside agents in return for cash, which can then be used in settlement. Willingness to settle in cash serves as a signal of the quality of a bank's assets; hence, in equilibrium all banks settle in cash. If information flows are disrupted so that no outsiders are informed, then the signaling value of cash settlement is lost. The last result is consistent with the use of debt-based settlement schemes during the National Banking Era (1864-1914).

JEL Classification: G21, N20, N21

working papers series





Not Available For Download

Date posted: July 2, 1998  

Suggested Citation

Kahn, Charles M. and Roberds, William, On the Efficiency of Cash Settlement (November 1995). WP 95-11. Available at SSRN: http://ssrn.com/abstract=7325

Contact Information

Charles M. Kahn
University of Illinois, Urbana-Champaign ( email )
Department of Finance
340 Wohlers Hall
Champaign, IL 61820
United States
217-333-2813 (Phone)
HOME PAGE: http://kahnfrance.com/cmk/
William Roberds (Contact Author)
Federal Reserve Bank of Atlanta ( email )
1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States
404-498-8970 (Phone)
404-498-8956 (Fax)
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