Liquidity Networks, Interconnectedness, and Interbank Information Asymmetry

40 Pages Posted: 11 May 2020 Last revised: 2 Mar 2021

See all articles by Celso Brunetti

Celso Brunetti

Board of Governors of the Federal Reserve System

Jeffrey H. Harris

American University - Department of Finance and Real Estate

Shawn Mankad

Cornell University

Multiple version iconThere are 2 versions of this paper

Date Written: February 28, 2021

Abstract

Network analysis has demonstrated that interconnectedness among market participants results in spillovers, amplifies or absorbs shocks, and creates other nonlinear effects that ultimately affect market health. In this paper, we propose a new directed network construct, the liquidity network, to capture the urgency to trade by connecting the initiating party in a trade to the passive party. Alongside the conventional trading network connecting sellers to buyers, we show both network types complement each other: Particularly when information asymmetry in the market is high, liquidity networks reveal valuable information, provide a more comprehensive characterization of interconnectivity in the overnight-lending market, and improve short-term forecasts of soft information and country-specific yield spreads. We also compare the information content of both networks with that of traditional volatility and volume measures. We find that in normal market conditions when interconnectedness is high, a further increase in connectivity of either network raises volatility. In crisis periods when interconnectedness is low, however, an increase in liquidity network connectivity reduces volatility and boosts traded volume. Our results reveal the dual nature of interconnectedness—too much interconnectedness may increase systemic risk, but too little may impede market functioning.

Keywords: banking networks, interconnectedness, liquidity

JEL Classification: G21, C10, G10

Suggested Citation

Brunetti, Celso and Harris, Jeffrey H. and Mankad, Shawn, Liquidity Networks, Interconnectedness, and Interbank Information Asymmetry (February 28, 2021). Available at SSRN: https://ssrn.com/abstract=3576512 or http://dx.doi.org/10.2139/ssrn.3576512

Celso Brunetti

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Jeffrey H. Harris

American University - Department of Finance and Real Estate ( email )

Kogod School of Business
4400 Massachusetts Ave., N.W.
Washington, DC 20016-8044
United States
202-885-6669 (Phone)

Shawn Mankad (Contact Author)

Cornell University ( email )

Ithaca, NY 14853
United States
6072559594 (Phone)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
77
Abstract Views
445
rank
361,799
PlumX Metrics