Edward "Ned" Prescott (Federal Reserve Bank of Cleveland)
Kalai Family Workshop in Business and Economics
Mar 7 2018
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Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation
Abstract: We report an experiment that assesses the effects of a liquidity requirement on interbank market performance. Baseline and liquidity-regulated regimes are analyzed in a simple shock environment, that features a single idiosyncratic shock, and in a compound shock environment, in which the idiosyncratic shock is followed by a stochastically occurring second shock. All shocks are followed by interbank trading of the illiquid asset. In the simple shock environment we find that liquidity regulations reduce the incidence of bankruptcies, but at a large loss of investment efficiency. In the compound shock environment, liquidity regulations fail to reduce bankruptcies as well as reduce investment efficiency.
Keywords: Interbank market, liquidity regulation, market experiments JEL codes: C9, G21