Rollover Risk, Liquidity, and Macro-Prudential Regulation
48 Pages Posted: 3 Jul 2014
Date Written: March 31, 2014
I study rollover risk in the wholesale funding market when intermediaries can hold liquidity ex-ante and are subject to fire sales ex-post. I demonstrate that precautionary liquidity restores multiple equilibria in a global rollover game. An intermediate liquidity level supports both the usual run equilibrium and an efficient equilibrium. I provide a uniqueness refinement to characterize the privately optimal liquidity choice. Because of fire sales, liquidity holdings are strategic substitutes. Intermediaries free-ride on the liquidity of other intermediaries, causing excessive liquidation. A macro-prudential authority internalizes the systemic nature of liquidity and restores constrained efficiency by imposing a macro-prudential liquidity buffer.
Keywords: global games, multiplicity, portfolio choice, wholesale funding
JEL Classification: G01, G11, G28
Suggested Citation: Suggested Citation