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The seed of a crisis: Investor sentiment and bank liquidity

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  • He, Liang

Abstract

This paper investigates the role of investor sentiment in bank liquidity. I argue that investor sentiment provides banks with a natural hedge against liquidity risk in normal times. However, banks are unaware that such hedge becomes invalid during a prolonging distress. I show that these together contribute to the excessive growth of credit lines in market booms, which may in turn plant the seed of a potential liquidity crisis.

Suggested Citation

  • He, Liang, 2019. "The seed of a crisis: Investor sentiment and bank liquidity," Finance Research Letters, Elsevier, vol. 29(C), pages 152-155.
    • Handle: RePEc:eee:finlet:v:29:y:2019:i:c:p:152-155
    DOI: 10.1016/j.frl.2018.06.014
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    References listed on IDEAS

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    1. Acharya, Viral V. & Pedersen, Lasse Heje, 2005. "Asset pricing with liquidity risk," Journal of Financial Economics, Elsevier, vol. 77(2), pages 375-410, August.
    2. Evan Gatev & Philip E. Strahan, 2006. "Banks' Advantage in Hedging Liquidity Risk: Theory and Evidence from the Commercial Paper Market," Journal of Finance, American Finance Association, vol. 61(2), pages 867-892, April.
    3. Dan Covitz & Chris Downing, 2007. "Liquidity or Credit Risk? The Determinants of Very Short‐Term Corporate Yield Spreads," Journal of Finance, American Finance Association, vol. 62(5), pages 2303-2328, October.
    4. Evan Gatev & Til Schuermann & Philip E. Strahan, 2009. "Managing Bank Liquidity Risk: How Deposit-Loan Synergies Vary with Market Conditions," The Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 995-1020, March.
    5. Malcolm Baker & Jeffrey Wurgler, 2006. "Investor Sentiment and the Cross‐Section of Stock Returns," Journal of Finance, American Finance Association, vol. 61(4), pages 1645-1680, August.
    6. Stambaugh, Robert F. & Yu, Jianfeng & Yuan, Yu, 2012. "The short of it: Investor sentiment and anomalies," Journal of Financial Economics, Elsevier, vol. 104(2), pages 288-302.
    7. Robert F. Stambaugh & Jianfeng Yu & Yu Yuan, 2015. "Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle," Journal of Finance, American Finance Association, vol. 70(5), pages 1903-1948, October.
    8. Viral V. Acharya & Nada Mora, 2015. "A Crisis of Banks as Liquidity Providers," Journal of Finance, American Finance Association, vol. 70(1), pages 1-43, February.
    9. Cornett, Marcia Millon & McNutt, Jamie John & Strahan, Philip E. & Tehranian, Hassan, 2011. "Liquidity risk management and credit supply in the financial crisis," Journal of Financial Economics, Elsevier, vol. 101(2), pages 297-312, August.
    10. Yu, Jianfeng & Yuan, Yu, 2011. "Investor sentiment and the mean-variance relation," Journal of Financial Economics, Elsevier, vol. 100(2), pages 367-381, May.
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    Cited by:

    1. Guo, Yumei & He, Shan, 2020. "Does confidence matter for economic growth? An analysis from the perspective of policy effectiveness," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 1-19.

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    More about this item

    Keywords

    Investor sentiment; Bank liquidity; Credit lines; Arbitrage risk;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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