Data Management

Endogenous Choice Of Bank Liquidity: The Role Of Fire Sales

Date Added: Nov 2009
Format: PDF

Banks' liquidity is a crucial determinant of the adversity of banking crises. In this paper, the authors consider the effect of fire sales and entry during crises on banks' ex-ante choice of liquid asset holdings. They consider a setting with limited pledgeability of risky cash flows relative to safe ones and a differential expertise between banks and outsiders in employing banking assets. When a large number of banks fail, market for assets clears only at fire-sale prices and outsiders enter the market if prices fall sufficiently low. In such states, there is a private benefit of liquid holdings to banks from purchasing assets.