Banks' Advantage in Hedging Liquidity Risk: Theory and Evidence from the Commercial Paper Market

42 Pages Posted: 26 Feb 2003

See all articles by Evan Gatev

Evan Gatev

Simon Fraser University

Philip E. Strahan

Boston College - Department of Finance; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: February 24, 2003

Abstract

This paper argues that banks have a unique ability to hedge against market-wide liquidity shocks. Deposit inflows provide a natural hedge for loan demand shocks that follow declines in market liquidity. Consequently, one dimension of bank "specialness" is that banks can insure firms against systematic declines in market liquidity at lower cost than other financial institutions. We provide supporting empirical evidence from the commercial paper (CP) market. When market liquidity dries up and CP spreads increase, banks experience funding inflows. These allow banks to meet increased loan demand from borrowers drawing funds from pre-existing commercial paper backup lines, without running down their holdings of liquid assets. Moreover, the supply of cheap funds is sufficiently large so that pricing on new lines of credit actually falls as market spreads widen.

Keywords: banking, liquidity, commercial paper

JEL Classification: G21, G12, G10

Suggested Citation

Gatev, Evan and Strahan, Philip E., Banks' Advantage in Hedging Liquidity Risk: Theory and Evidence from the Commercial Paper Market (February 24, 2003). Available at SSRN: https://ssrn.com/abstract=368131 or http://dx.doi.org/10.2139/ssrn.368131

Evan Gatev (Contact Author)

Simon Fraser University ( email )

Burnaby, British Columbia V5A 1S6
Canada

Philip E. Strahan

Boston College - Department of Finance ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States
617-552-6430 (Phone)
617-552-0431 (Fax)

HOME PAGE: http://www2.bc.edu/~strahan

National Bureau of Economic Research (NBER)

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United States

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