The Creditor Channel of Liquidity Crises
53 Pages Posted: 6 Apr 2009 Last revised: 24 Sep 2018
Date Written: October 1, 2016
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: Suggested Citation