Liquidity Hoarding

66 Pages Posted: 26 Mar 2011  

Douglas M. Gale

New York University (NYU) - Department of Economics

Tanju Yorulmazer

University of Amsterdam - Faculty of Economics and Business (FEB)

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Date Written: March 1, 2011

Abstract

Banks hold liquid and illiquid assets. An illiquid bank that receives a liquidity shock sells assets to liquid banks in exchange for cash. We characterize the constrained efficient allocation as the solution to a planner’s problem and show that the market equilibrium is constrained inefficient, with too little liquidity and inefficient hoarding. Our model features a precautionary as well as a speculative motive for hoarding liquidity, but the inefficiency of liquidity provision can be traced to the incompleteness of markets (due to private information) and the increased price volatility that results from trading assets for cash.

Keywords: interbank market, fire sale

JEL Classification: G12, G21, G24, G32, G33, D8

Suggested Citation

Gale, Douglas M. and Yorulmazer, Tanju, Liquidity Hoarding (March 1, 2011). FRB of New York Staff Report No. 488. Available at SSRN: https://ssrn.com/abstract=1794062 or http://dx.doi.org/10.2139/ssrn.1794062

Douglas M. Gale

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10011
United States
(212) 998-8944 (Phone)
(212) 995-3932 (Fax)

Tanju Yorulmazer (Contact Author)

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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