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Balancing liquidity and returns through interbank markets: Endogenous interest rates and network structures

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  • Di Xiao
  • Andreas Krause

Abstract

In this article, we develop a model of interbank lending based on liquidity and return on equity considerations of homogeneous banks. We derive the reservation prices of interbank lending and its properties before exploring how, because of an idiosyncratic liquidity shock, banks engage in bilateral lending to form an interbank network. We establish that the resulting networks exhibit realistic properties, including a core‐periphery structure. Banks in the core and the periphery of this network differ not only in the amounts of interbank lending and borrowing but also in the interest rates applied to their transactions.

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  • Di Xiao & Andreas Krause, 2023. "Balancing liquidity and returns through interbank markets: Endogenous interest rates and network structures," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 46(1), pages 131-149, February.
    • Handle: RePEc:bla:jfnres:v:46:y:2023:i:1:p:131-149
    DOI: 10.1111/jfir.12309
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