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Leaning Against the Wind

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Author Info
PIERRE-OLIVIER WEILL

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Abstract

During financial disruptions, market makers provide liquidity by absorbing external selling pressure. They buy when the pressure is large, accumulate inventories, and sell when the pressure alleviates. This paper studies optimal dynamic liquidity provision in a theoretical market setting with large and temporary selling pressure and order-execution delays. I show that competitive market makers offer the socially optimal amount of liquidity, provided they have access to sufficient capital. If raising capital is costly, this suggests a policy role for lenient central bank lending during financial disruptions. Copyright 2007 The Review of Economic Studies Limited.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1467-937X.2007.00451.x
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Publisher Info
Article provided by Blackwell Publishing in its journal Review of Economic Studies.

Volume (Year): 74 (2007)
Issue (Month): 4 (October)
Pages: 1329-1354
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Handle: RePEc:bla:restud:v:74:y:2007:i:4:p:1329-1354

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  1. Ricardo Lagos & Guillaume Rocheteau, 2006. "Search in asset markets," Staff Report 375, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  2. Ricardo Lagos & Guillaume Rocheteau, 2008. "Liquidity in asset markets with search frictions," Staff Report 408, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  3. Ricardo Lagos, 2008. "The Research Agenda: Ricardo Lagos on Liquidity and the Search Theory of Money," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 10(1), November. [Downloadable!]
  4. Junjian Miao, . "A search model of centralized and decentralized trade," Boston University - Department of Economics - Macroeconomics Working Papers Series WP2005-012, Boston University - Department of Economics, revised Oct 2005. [Downloadable!]
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  5. Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2009. "Crises and Liquidity in Over-the-Counter Markets," NBER Working Papers 15414, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Sun, Yeneng & Zhang , Yongchao, 2008. "Individual Risk and Lebesgue Extension without Aggregate Uncertainty," MPRA Paper 7448, University Library of Munich, Germany. [Downloadable!]
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  7. Darrell Duffie & Bruno Strulovici, 2009. "Capital Mobility and Asset Pricing," Discussion Papers 1478, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
  8. Arvind Krishnamurthy, 2009. "Amplification Mechanisms in Liquidity Crises," NBER Working Papers 15040, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. BIAIS, Bruno & WEILL, Pierre-Olivier, 2009. "Liquidity Shocks and Order Book Dynamics," IDEI Working Papers 550, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
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  10. Nicolae B. Garleanu & Lasse H. Pedersen, 2007. "Liquidity and Risk Management," NBER Working Papers 12887, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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This page was last updated on 2009-10-26.

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