Outside and Inside Liquidity

The Quarterly Journal of Economics, Vol. 126, No. 1, pp. 259-321, 2011

Columbia Business School Research Paper No. 11-30

Economic Theory Center Working Paper No. 35-2012

66 Pages Posted: 22 Oct 2011 Last revised: 31 May 2012

See all articles by Patrick Bolton

Patrick Bolton

Columbia Business School - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Tano Santos

Columbia Business School; National Bureau of Economic Research (NBER)

José Scheinkman

Columbia University; Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: 2011

Abstract

We propose an origination-and-contingent-distribution model of banking, in which liquidity demand by short-term investors (banks) can be met with cash reserves (inside liquidity) or sales of assets (outside liquidity) to long-term investors (hedge funds and pension funds). Outside liquidity is a more efficient source, but asymmetric information about asset quality can introduce a friction in the form of excessively early asset trading in anticipation of a liquidity shock, excessively high cash reserves, and too little origination of assets by banks. The model captures key elements of the financial crisis and yields novel policy prescriptions.

Suggested Citation

Bolton, Patrick and Santos, Tano and Scheinkman, José, Outside and Inside Liquidity (2011). The Quarterly Journal of Economics, Vol. 126, No. 1, pp. 259-321, 2011; Columbia Business School Research Paper No. 11-30; Economic Theory Center Working Paper No. 35-2012. Available at SSRN: https://ssrn.com/abstract=1946961

Patrick Bolton (Contact Author)

Columbia Business School - Department of Economics ( email )

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HOME PAGE: http://www0.gsb.columbia.edu/faculty/pbolton/

Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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European Corporate Governance Institute (ECGI)

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Tano Santos

Columbia Business School ( email )

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National Bureau of Economic Research (NBER)

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José Scheinkman

Columbia University ( email )

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Princeton University - Department of Economics ( email )

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HOME PAGE: http://www.princeton.edu/~joses

National Bureau of Economic Research (NBER)

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