Money and Liquidity in Financial Markets

55 Pages Posted: 19 Jul 2010

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 2010

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 support this hypothesis. While our data covers part of the recent crisis period, our results are not driven by the crisis. Our general point is that money matters in financial markets. Different financial assets have different degrees of moneyness (liquidity) and, as a result, there are systematic cross-sectional variations in trading activity as the price of liquidity, or the level of tightness, in the interbank market fluctuates.

Keywords: interbank and financial markets, liquidity, liquidity pull-back, money

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

Suggested Citation

Nyborg, Kjell G. and Östberg, Per, Money and Liquidity in Financial Markets (June 2010). CEPR Discussion Paper No. DP7905, Available at SSRN: https://ssrn.com/abstract=1640982

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

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