Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation
37 Pages Posted: 1 Aug 2018
Date Written: July 31, 2018
We develop a stylized interbank market environment and use it to evaluate with experimental methods the effects of liquidity requirements. Baseline and liquidity-regulated regimes are analyzed in a simple shock environment, which features a single idiosyncratic shock, and in a compound shock environment, in which the idiosyncratic shock is followed by a randomly occurring second-stage shock. Interbank trading of the illiquid asset follows each shock. In the simple shock environment, we find that liquidity regulations reduce the incidence of bankruptcies, but at a large loss of investment efficiency. In the compound shock environment, liquidity regulations not only impose a loss of investment efficiency but also fail to reduce bankruptcies.
Keywords: Interbank market, liquidity regulation, market experiments
JEL Classification: C9, G21
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