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Leaning Against the Wind

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  • Pierre-Olivier Weill

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, Wiley-Blackwell.

Suggested Citation

  • Pierre-Olivier Weill, 2007. "Leaning Against the Wind," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 74(4), pages 1329-1354.
    • Handle: RePEc:oup:restud:v:74:y:2007:i:4:p:1329-1354
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    File URL: http://hdl.handle.net/10.1111/j.1467-937X.2007.00451.x
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    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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