The Creditor Channel of Liquidity Crises

53 Pages Posted: 6 Apr 2009 Last revised: 24 Sep 2018

See all articles by Xuewen Liu

Xuewen Liu

University of Hong Kong (HKU) - Finance Area, Faculty of Business and Economics

Antonio S. Mello

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Date Written: October 1, 2016

Abstract

This paper presents a model to study the transmission of liquidity shocks across financial institutions through the creditor channel. In the model, a borrower institution obtains funds from a large institutional lender and small investors. When the large lender's asset market is hit by a liquidity shock, it might decide to withdraw funding extended to the borrower. The potential withdrawal by the large lender causes small investors to panic and to close positions even if the large lender does not. Facing funding problems, the borrower has to cut its activities, contributing to further shocks to the supply of market liquidity. The original shock is exacerbated, which reinforces withdrawals by all creditors. The model helps explain how the spreading of liquidity shocks from the broker-dealer sector to the hedge fund sector and the feedback contribute to a systemic crisis.

Keywords: systemic crises, creditor runs, market liquidity, coordination risk, amplifications

JEL Classification: G01, G14, G21, G23, G24, D83, D53

Suggested Citation

Liu, Xuewen and Mello, Antonio S., The Creditor Channel of Liquidity Crises (October 1, 2016). Journal of Money, Credit, and Banking, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1320684 or http://dx.doi.org/10.2139/ssrn.1320684

Xuewen Liu (Contact Author)

University of Hong Kong (HKU) - Finance Area, Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

HOME PAGE: http://web.hku.hk/~xuewenl/

Antonio S. Mello

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States
608-263-3423 (Phone)
608-265-4195 (Fax)

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