Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/25558
Authors: 
Cao, Jin
Illing, Gerhard
Year of Publication: 
2008
Series/Report no.: 
CFS Working Paper 2008/23
Abstract: 
Traditionally, aggregate liquidity shocks are modelled as exogenous events. Extending our previous work (Cao & Illing, 2007), this paper analyses the adequate policy response to endogenous systemic liquidity risk. We analyse the feedback between lender of last resort policy and incentives of private banks, determining the aggregate amount of liquidity available. We show that imposing minimum liquidity standards for banks ex ante are a crucial requirement for sensible lender of last resort policy. In addition, we analyse the impact of equity requirements and narrow banking, in the sense that banks are required to hold sufficient liquid funds so as to pay out in all contingencies. We show that such a policy is strictly inferior to imposing minimum liquidity standards ex ante combined with lender of last resort policy.
Subjects: 
Liquidity Risk
Free-Riding
Narrow Banking
Lender of Last Resort
JEL: 
E5
G21
G28
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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