Working Paper: CEPR ID: DP7905
Authors: Kjell G. Nyborg; Per Ståberg
Abstract: We argue that there is a connection between the interbank market for liquidity and the broader financial markets, which has its basis in demand for liquidity by banks. Tightness in the interbank market for liquidity leads banks to engage in what we term "liquiditypull-back," which involves selling financial assets either by banks directly or by levered investors. Empirical tests support this hypothesis. While our data covers part of the recent crisis period, our results are not driven by the crisis. Our general point is that money matters in financial markets. Different financial assets have different degrees of moneyness (liquidity) and, as a result, there are systematic cross-sectional variations in trading activity as the price of liquidity, or the level of tightness, in the interbank market fluctuates.
Keywords: interbank; financial markets; liquidity; liquidity pullback; money
JEL Codes: E41; E44; E51; G12; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity pullback by banks (E44) | asset sales (H82) |
| tightness of the interbank market (E44) | volume of trading in financial markets (G15) |
| price of liquidity (measured by LIBOR-OIS and TED spreads) (E43) | volume of trading in more liquid stocks (G10) |
| price of liquidity (measured by LIBOR-OIS and TED spreads) (E43) | volume of trading in illiquid stocks (G10) |
| high spread days (G14) | volume of liquid stocks (G15) |
| high spread days (G14) | returns on stocks (G12) |