Liquidity Freezes Under Adverse Selection
53 Pages
Posted: 1 Apr 2014
Last revised: 9 Jul 2016
Universidade do Porto, Faculdade de Economia. CEF.UP
University of Illinois, Urbana-Champaign; Feseral Reserve Bank of Saint Louis; Bank of Canada
Date Written: June 2016
Abstract
This paper analyses how adverse selection prevents liquidity from flowing from liquid to illiquid firms, thus impairing the transmission mechanism of policy. Contrary to the results in the literature, simply increasing the availability of liquidity does not solve the adverse selection problem. When there are aggregate shocks, authorities face a policy dilemma if their single policy tool is to manipulate the price of liquidity. We consider alternative policies which address the problem in a time-consistent fashion.
Keywords: liquidity; adverse selection; funding liquidity risk; financial market freezes
JEL Classification: E44, E52, G28
Suggested Citation:
Suggested Citation
Jorge, José and Kahn, Charles M., Liquidity Freezes Under Adverse Selection (June 2016). Available at SSRN: https://ssrn.com/abstract=2419170 or http://dx.doi.org/10.2139/ssrn.2419170
