Abstract: We study banks' balance sheet formation in the context of liquidity risk management. Using global games techniques, we derive a marginal liquidity multiplier, the size of the deposit base expansiona bank can perform when its liquidity buffer increases by one unit, without changing exposure to liquidity risk. We explain intuitively and prove formally that this multiplier is larger than one, and show that it is key for the characterization of the optimal balance sheet. Our theory has implications for the pricing of liquid securities and explains why banks hoard so many liquid assets whose yield is often lower than the cost of their deposits. It also allows to analyze the role of public liquidity provision: while increasing the supply of liquid assets improves welfare, it can also increase run probability, as banks can respond by issuing more deposits.
Publication Year: 2020
Publication Date: 2020-01-01
Language: en
Type: article
Indexed In: ['crossref']
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Cited By Count: 1
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