Outside Liquidity, Rollover Risk, and Government Bonds

40 Pages Posted: 25 Sep 2014

See all articles by Stephan Luck

Stephan Luck

Federal Reserve Bank of New York

Paul Schempp

University of Cologne - Center for Macroeconomic Research (CMR); Max Planck Institute for Research on Collective Goods

Date Written: September 2014

Abstract

This paper discusses whether financial intermediaries can optimally provide liquidity, or whether the government has a role in creating liquidity by supplying government securities. We discuss a model in which intermediaries optimally manage liquidity with outside rather than inside liquidity: instead of holding liquid real assets that can be used at will, banks sell claims on long-term projects to investors. While increasing efficiency, liquidity management with private outside liquidity is associated with a rollover risk. This rollover risk either keeps intermediaries from providing liquidity optimally, or it makes the economy inherently fragile. In contrast to privately produced claims, government bonds are not associated with coordination problems unless there is the prospect that the government may default. Therefore, efficiency and stability can be enhanced if liquidity management relies on public outside liquidity.

Keywords: liquidity provision, liquidity mismatch, bank run, roll-over freeze, outside liquidity, government bonds, liquidity regulation

JEL Classification: G21, G28, H81, H63

Suggested Citation

Luck, Stephan and Schempp, Paul, Outside Liquidity, Rollover Risk, and Government Bonds (September 2014). MPI Collective Goods Preprint, No. 2014/14, Available at SSRN: https://ssrn.com/abstract=2500797 or http://dx.doi.org/10.2139/ssrn.2500797

Stephan Luck

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Paul Schempp (Contact Author)

University of Cologne - Center for Macroeconomic Research (CMR) ( email )

Cologne
Germany

Max Planck Institute for Research on Collective Goods ( email )

Kurt-Schumacher-Str. 10
D-53113 Bonn, 53113
Germany

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