Interbank market liquidity and central bank intervention

By Franklin Allen, Elena Carletti, Douglas Gale. 2009

405 citations recorded by the source corpus.

We develop a simple model of the interbank market where banks trade a long term, safe asset. When there is a lack of opportunities for banks to hedge idiosyncratic and aggregate liquidity shocks, the interbank market is characterized by excessive price volatility. In such a situation, a central bank can implement the constrained efficient allocation by using open market operations to fix the short term interest rate. It can be constrained efficient for banks to hoard liquidity and stop trading with each other if there is sufficient uncertainty about aggregate liquidity demand compared to idiosyncratic liquidity demand.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/b8e2ea4253a8262334fe756e40ec03ab99e963fb

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Citations in the corpus

Illiquid Banks, Financial Stability, and Interest Rate Policy (2012, background): “Important work in this area includes Jacklin (1987), Diamond (1997), Lorenzoni (2001), Allen, Carletti, and Gale (2009), and Freixas, Martin, and Skeie (2011).”
The Role of Liquidity in Financial Crises (2008, background): “By engaging in open market operations to fix the price of the long asset (or equivalently fix the short-term interest rate), central banks can remove the inefficiency deriving from the asset price volatility and achieve the same allocation as with complete markets (Allen, Carletti and Gale, 2008).”
The Term Structure of Interbank Risk (2012, neutral): “3 The precautionary motive for cash hoarding is modeled by Allen, Carletti, and Gale (2009) and Acharya and Skeie (2011).”
The Interbank Market after the Financial Turmoil: Squeezing Liquidity in a 'Lemons Market' or Asking Liquidity 'on Tap' (2013, positive): “A related strand of literature, following Allen and Gale (2000) and Diamond and Rajan (2005) analyse the effect of liquidity shocks on interbank market (Brunnermeier and Pedersen, 2009) also including the role played by central banks (Allen et al., 2009).”
Do Interbank Customer Relationships Exist? And How Did They Function in the Crisis? Learning from Italy (2012, neutral): “On the one hand, some authors – Bhattacharya and Gale (1987), Flannery (1996), Allen and Gale (2000), Freixas et al. (2000), Freixas and Jorge (2007) Allen et al. (2008) – signal that banks should not be able to monitor their peers because interbank markets, like other credit markets, are…”
Contagion and risk-sharing on the inter-bank market (2013, background): “Allen et al. (2009) have shown how a central bank may limit volatility through993 open market operations.”
Liquidity hoarding and interbank market rates: The role of counterparty risk (2015, neutral): “subject to Ll = (1 �I) �lc1 ( 4 ) Lh = �hc1 (1 �I): (5)”
Limits to arbitrage during the crisis: funding liquidity constraints and covered interest parity (2011, neutral): “…Rajan (2005), He and Krishnamurthy (2008b) and Duffie (2009), the structure of markets, as in Acharya and Pedersen (2005), Allen and Gale (2003), Allen, Carletti, and Gale (2009) and Lagos, Rocheteau, and Weill (2009), or adverse selection or investor sentiment as in Malliaris and Yan (2010),…”
Transmission channels of systemic risk and contagion in the European financial network (2015, positive): “Allen et al. (2009), Brunnermeier and Pederson (2009), and Allen et al. (2011), use bilateral exposures in the interbank market to observe that a strongly connected banking network mitigates systemic risk by transferring the proportion of losses from one bank’s portfolio to more banks through…”