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A dealer’s funding liquidity risk and its money market trades in the 2007/08 crisis

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  • Fecht, Falko
  • Reitz, Stefan
  • Weber, Patrick

Abstract

In this study, we examine the trading book of a major dealer in the European unsecured money market, focusing on the impact of a dealer’s own funding liquidity risk on the pricing of his interbank trades pre- and post- the 2007/08 financial crisis. Our analysis reveals two key insights: First, utilizing a panel model, we observe that heightened funding liquidity risks for the dealer generally affect his quoted prices for interbank liquidity. Second, while in tranquil periods this effect is statistically significant but economically less pronounced, the collapse of Lehman Brothers led to a strong liquidity pricing effect: a one standard deviation increase in the funding liquidity risk of the dealer translated to a 11 basis points higher mid-price for overnight liquidity. We thus find evidence that funding liquidity risks exacerbated the overall contraction of money market liquidity during this period.

Suggested Citation

  • Fecht, Falko & Reitz, Stefan & Weber, Patrick, 2024. "A dealer’s funding liquidity risk and its money market trades in the 2007/08 crisis," Journal of Financial Stability, Elsevier, vol. 75(C).
    • Handle: RePEc:eee:finsta:v:75:y:2024:i:c:s1572308924001220
    DOI: 10.1016/j.jfs.2024.101337
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    More about this item

    Keywords

    Funding liquidity risk and money market liquidity; Liquidity constraints; Money market dealers; Liquidity spirals;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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