Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation

37 Pages Posted: 1 Aug 2018

See all articles by Douglas D. Davis

Douglas D. Davis

Virginia Commonwealth University - School of Business - Department of Economics

Oleg Korenok

Virginia Commonwealth University - School of Business

John P. Lightle

Florida State University - Department of Economics

Edward S. Prescott

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Date Written: July 31, 2018

Abstract

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

Suggested Citation

Davis, Douglas D. and Korenok, Oleg and Lightle, John P. and Prescott, Edward (Ned) Simpson, Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation (July 31, 2018). FRB of Cleveland Working Paper No. 18-10. Available at SSRN: https://ssrn.com/abstract=3223870 or http://dx.doi.org/10.2139/ssrn.3223870

Douglas D. Davis (Contact Author)

Virginia Commonwealth University - School of Business - Department of Economics ( email )

Box 844000
Richmond, VA 23284-4000
United States

Oleg Korenok

Virginia Commonwealth University - School of Business ( email )

1015 Floyd Avenue
Richmond, VA 23284-4000
United States

John P. Lightle

Florida State University - Department of Economics ( email )

Tallahassee, FL 30306-2180
United States

Edward (Ned) Simpson Prescott

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

P.O. Box 6387
Cleveland, OH 44101
United States

HOME PAGE: http://https://www.clevelandfed.org/people-search?pid=f8ca941e-4b51-41f6-95f8-c87f1d3806e5

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