Fire Sales, the LOLR and Bank Runs With Continuous Asset Liquidity

19 Pages Posted: 3 Dec 2020

See all articles by Ulrich Bindseil

Ulrich Bindseil

European Central Bank (ECB)

Edoardo Lanari

Institute of Mathematics, Czech Academy of Sciences,

Date Written: October 21, 2020

Abstract

Bank's asset fire sales and recourse to central bank credit are modelled with continuous asset liquidity, allowing to derive the liability structure of a bank. Both asset sales liquidity and the central bank collateral framework are modeled as power functions within the unit interval. Funding stability is captured as a strategic bank run game in pure strategies between depositors. Fire sale liquidity and the central bank collateral framework determine jointly the ability of the banking system to deliver maturity transformation without endangering financial stability. The model also explains why banks tend to use the least liquid eligible collateral with the central bank and why a sudden non-anticipated reduction of asset liquidity, or a tightening of the collateral framework, can trigger a bank run. The model also shows that the collateral framework can be understood, beyond its aim to protect the central bank, as financial stability and non-conventional monetary policy instrument.

Keywords: Fire Sales, lender-of-last resort, bank run, capital structure, asset liquidity, collateral, bank intermediation spreads.

JEL Classification: C61, E43, E58, G.21, G32, G33

Suggested Citation

Bindseil, Ulrich and Lanari, Edoardo, Fire Sales, the LOLR and Bank Runs With Continuous Asset Liquidity (October 21, 2020). Available at SSRN: https://ssrn.com/abstract=3716524 or http://dx.doi.org/10.2139/ssrn.3716524

Ulrich Bindseil (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Edoardo Lanari

Institute of Mathematics, Czech Academy of Sciences, ( email )

Brno, CZ-60300
Czech Republic

HOME PAGE: http://https://edolana.github.io/

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