Money and Liquidity in Financial Markets

65 Pages Posted: 21 Jun 2010 Last revised: 15 Jul 2013

See all articles by Kjell G. Nyborg

Kjell G. Nyborg

University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Per Östberg

University of Zurich - Department of Banking and Finance; Swiss Finance Institute

Multiple version iconThere are 2 versions of this paper

Date Written: June 2013

Abstract

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 on the stock market are supportive. Tighter interbank markets are associated with relatively more volume in more liquid stocks; selling pressure, especially in more liquid stocks; and transitory negative returns. We control for market-wide uncertainty and in the process also contribute to the literature on portfolio rebalancing. Our general point is that money matters in financial markets.

Keywords: money, liquidity, interbank and financial markets, liquidity pull-back, volume, order imbalance, returns, portfolio rebalancing, Libor-OIS spread, VIX

JEL Classification: G12, G21, G11, E41, E44, E51

Suggested Citation

Nyborg, Kjell G. and Östberg, Per, Money and Liquidity in Financial Markets (June 2013). Swiss Finance Institute Research Paper No. 10-25, Available at SSRN: https://ssrn.com/abstract=1625648 or http://dx.doi.org/10.2139/ssrn.1625648

Kjell G. Nyborg (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland
+41 (0)44 634 2980 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Per Östberg

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
CH-8032 Zurich, Zurich 8032
Switzerland
+41 44 6342956 (Phone)

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland