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Money and liquidity in financial markets


Nyborg, Kjell G; Östberg, Per Nils Anders (2010). Money and liquidity in financial markets. Swiss Finance Institute Research Paper 10-25, University of Zurich.

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 “liquidity pull-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.

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 “liquidity pull-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.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:2010
Deposited On:08 Apr 2013 08:16
Last Modified:05 Apr 2016 16:26
Series Name:Swiss Finance Institute Research Paper
Number of Pages:57
Official URL:http://ssrn.com/abstract=1625648
Related URLs:http://www.zora.uzh.ch/93848/
Other Identification Number:merlin-id:4877
Permanent URL: https://doi.org/10.5167/uzh-72506

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