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Liquidity (Risk) Concepts: Definitions and Interactions

Kleopatra Nikolaou

Federal Reserve Board of Governors

February 23, 2009

ECB Working Paper No. 1008

We discuss the notion of liquidity and liquidity risk within the financial system. We distinguish between three different liquidity types, central bank liquidity, funding and market liquidity and their relevant risks. In order to understand the workings of financial system liquidity, as well as the role of the central bank, we bring together relevant literature from different areas and review liquidity linkages among these three types in normal and turbulent times. We stress that the root of liquidity risk lies in information asymmetries and the existence of incomplete markets. The role of central bank liquidity can be important in managing a liquidity crisis, yet it is not a panacea. It can act as an immediate but temporary buyer to liquidity shocks, thereby allowing time for supervision and regulation to confront the causes of liquidity risk.

Number of Pages in PDF File: 72

Keywords: liquidity, risk, central bank, LLR

JEL Classification: G10, G20

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Date posted: February 23, 2009  

Suggested Citation

Nikolaou, Kleopatra, Liquidity (Risk) Concepts: Definitions and Interactions (February 23, 2009). ECB Working Paper No. 1008. Available at SSRN: https://ssrn.com/abstract=1333568

Contact Information

Kleopatra Nikolaou (Contact Author)
Federal Reserve Board of Governors ( email )
20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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