Inefficiency and Regulation of Private Liquidity

56 Pages Posted: 25 Apr 2019 Last revised: 27 Aug 2019

See all articles by Pierpaolo Benigno

Pierpaolo Benigno

Luiss Guido Carli University; Einaudi Institute for Economics and Finance (EIEF)

Roberto Robatto

University of Wisconsin - Madison

Multiple version iconThere are 2 versions of this paper

Date Written: August 23, 2019

Abstract

We propose a simple model to study the efficiency of private liquidity creation by financial intermediaries. Liquidity is provided by both safe and risky debt, and liquidity crises arise when risky debt is defaulted on and stops providing liquidity services. Because of a novel externality related to liquidity premia and the cost of issuing safe debt, the equilibrium is inefficient and characterized by an excessive supply of risky debt. However, the optimal regulation requires that not only risky but also safe debt be targeted, and regulating risky debt alone has unintended welfare-reducing consequences.

Keywords: Private liquidity creation, safe assets, risky liquidity, procyclical financial regulation, capital requirements

JEL Classification: G01, G20, E44

Suggested Citation

Benigno, Pierpaolo and Robatto, Roberto, Inefficiency and Regulation of Private Liquidity (August 23, 2019). Available at SSRN: https://ssrn.com/abstract=3360703 or http://dx.doi.org/10.2139/ssrn.3360703

Pierpaolo Benigno

Luiss Guido Carli University

Viale Romania 32
Rome, Roma 00197
Italy

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Due Macelli, 73
Rome, 00187
Italy

Roberto Robatto (Contact Author)

University of Wisconsin - Madison ( email )

975 University Avenue
Madison, WI 53706
United States

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