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
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: Suggested Citation