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The role of investor sentiment in bank liquidity creation

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  • Cai, Jin
  • Pagano, Michael S.
  • Sedunov, John

Abstract

Using a comprehensive, forward-looking estimate of investor sentiment based on equity, option, and fixed income markets, we find that investor sentiment is positively related to bank liquidity creation, LC. As investors become more optimistic, both asset-based and off-balance sheet LC rise while liability-based LC decreases, which results in a net increase in LC. The effect is seen in large banks’ LC, while the impact on small banks’ LC is weaker. A channel analysis finds increases in sentiment and bank LC coincide with greater lending that is financed by liquidating cash and securities, as well as by relying on non-depository sources.

Suggested Citation

  • Cai, Jin & Pagano, Michael S. & Sedunov, John, 2023. "The role of investor sentiment in bank liquidity creation," Finance Research Letters, Elsevier, vol. 58(PD).
    • Handle: RePEc:eee:finlet:v:58:y:2023:i:pd:s1544612323010358
    DOI: 10.1016/j.frl.2023.104663
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    References listed on IDEAS

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    More about this item

    Keywords

    Banks; Liquidity creation; Sentiment; Depository institutions;
    All these keywords.

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G40 - Financial Economics - - Behavioral Finance - - - General

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