Funding Liquidity, Market Liquidity and TED Spread: A Two-Regime Model

Abstract

We investigate the effect of market liquidity on equity-collateralized funding accounting for endogeneity. Theory suggests market liquidity can affect funding liquidity in stabilizing and destabilizing manners. Using the average fee on stock loans as a proxy for equity-collateralized funding liquidity, we confirm the existence of these two regimes over the period of July 2006-May 2011. Furthermore, we show that we can separate the two regimes using the yield spread of Eurodollars over T-bills (TED spread) and that a regime switch seems to occur near a TED spread of 48 basis points.

Keywords: equity-collateralized funding liquidity; market liquidity; two-regime model; financial distress

JEL Classification: EF, G01, G18