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

60 Pages Posted: 10 Sep 2003 Last revised: 16 Sep 2022

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: September 2003

Abstract

This paper argues that banks have a unique ability to hedge against market-wide liquidity shocks. Deposit inflows provide funding 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 flows 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.

Suggested Citation

Gatev, Evan and Strahan, Philip E., Banks' Advantage in Hedging Liquidity Risk: Theory and Evidence from the Commercial Paper Market (September 2003). NBER Working Paper No. w9956, Available at SSRN: https://ssrn.com/abstract=441589

Evan Gatev

Simon Fraser University ( email )

Burnaby, British Columbia V5A 1S6
Canada

Philip E. Strahan (Contact Author)

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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