A Model of Liquidity Hoarding and Term Premia in Inter-Bank Markets

Acharya, Viral V.; Skeie, David R.

doi:10.2139/ssrn.1856125

Download This Paper

Open PDF in Browser

Add Paper to My Library

A Model of Liquidity Hoarding and Term Premia in Inter-Bank Markets

FRB of New York Staff Report No. 498

35 Pages Posted: 31 May 2011

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

David R. Skeie

University of Warwick - Warwick Business School

There are 2 versions of this paper

Date Written: May 1, 2011

Abstract

Financial crises are associated with reduced volumes and extreme levels of rates for term inter-bank loans, reflected in the one-month and three-month Libor. We explain such stress by modeling leveraged banks’ precautionary demand for liquidity. Asset shocks impair a bank’s ability to roll over debt because of agency problems associated with high leverage. In turn, banks hoard liquidity and decrease term lending as their rollover risk increases over the term of the loan. High levels of short-term leverage and illiquidity of assets lead to low volumes and high rates for term borrowing. In extremis, inter-bank markets can completely freeze.

Keywords: inter-bank lending, financial crisis, precautionary demand, rollover risk, LIBOR-OIS spread

JEL Classification: G21, G01, E43

Suggested Citation: Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Skeie, David R., A Model of Liquidity Hoarding and Term Premia in Inter-Bank Markets (May 1, 2011). FRB of New York Staff Report No. 498, Available at SSRN: https://ssrn.com/abstract=1856125 or http://dx.doi.org/10.2139/ssrn.1856125