Liquidity Creation and Financial Stability: The Role of Hidden Trades

45 Pages Posted: 2 Sep 2015 Last revised: 23 Jul 2018

Date Written: May 15, 2018

Abstract

This paper studies liquidity insurance by financial intermediaries when agents can make unobservable side trades. Closed-end mutual funds of Jacklin (1987) achieve constrained efficiency when regulated appropriately, equilibrium is unique, and there are no financial panics. In an economy with banks funded by demand deposits, financial panics also do not arise when banks and depositors can trade in a credit market. These results highlight the central role played by trading possibilities in shaping liquidity creation and financial stability.

Keywords: Liquidity creation, liquidity insurance, hidden trades, bank runs, financial stability

JEL Classification: D91, E61, G21, G23, G28

Suggested Citation

Kucinskas, Simas, Liquidity Creation and Financial Stability: The Role of Hidden Trades (May 15, 2018). Available at SSRN: https://ssrn.com/abstract=2654168 or http://dx.doi.org/10.2139/ssrn.2654168

Simas Kucinskas (Contact Author)

Humboldt University of Berlin

Dorotheenstrasse 1
Berlin, Berlin 10099
Germany

HOME PAGE: http://www.simaskucinskas.com

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