IDEAS home Printed from https://ideas.repec.org/p/ime/imedps/15-e-14.html
   My bibliography  Save this paper

The Interaction between Funding Liquidity and Market Liquidity: Evidence from Subprime and European Crises

Author

Listed:
  • Azusa Takeyama

    (Director and Senior Economist, Institute for Monetary and Economic Studies (currently Financial System and Bank Examination Department), Bank of Japan (E-mail: azusa.takeyama@boj.or.jp))

  • Naoshi Tsuchida

    (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: naoshi.tsuchida@boj.or.jp))

Abstract

This paper explores the interaction between funding liquidity and market liquidity. The simultaneous reduction of funding and market liquidities is often observed during financial crises. While Brunnermeier and Pedersen (2009) argue that fragility of liquidity is due to a destabilizing effect of margin calls triggered by uninformed traders' behavior under uncertainty, Nyborg and Östberg (2014) claim that the malfunction in interbank funding markets causes declines in market liquidity in broader financial markets. We demonstrate that Nyborg and Östberg's cause was dominant during the subprime financial crisis, while both causes were valid during the European sovereign debt crisis using a structural vector autoregression model.

Suggested Citation

  • Azusa Takeyama & Naoshi Tsuchida, 2015. "The Interaction between Funding Liquidity and Market Liquidity: Evidence from Subprime and European Crises," IMES Discussion Paper Series 15-E-14, Institute for Monetary and Economic Studies, Bank of Japan.
    • Handle: RePEc:ime:imedps:15-e-14
    as

    Download full text from publisher

    File URL: http://www.imes.boj.or.jp/research/papers/english/15-E-14.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Arvind Krishnamurthy & Stefan Nagel & Dmitry Orlov, 2014. "Sizing Up Repo," Journal of Finance, American Finance Association, vol. 69(6), pages 2381-2417, December.
    2. Ben S. Bernanke & Kenneth N. Kuttner, 2005. "What Explains the Stock Market's Reaction to Federal Reserve Policy?," Journal of Finance, American Finance Association, vol. 60(3), pages 1221-1257, June.
    3. Melvin, Michael & Taylor, Mark P., 2009. "The crisis in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 28(8), pages 1317-1330, December.
    4. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
    5. Darrell Duffie & Nicolae Gârleanu & Lasse Heje Pedersen, 2007. "Valuation in Over-the-Counter Markets," The Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 1865-1900, November.
    6. Michael J. Fleming, 2003. "Measuring treasury market liquidity," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 83-108.
    7. Nyborg, Kjell G. & Östberg, Per, 2014. "Money and liquidity in financial markets," Journal of Financial Economics, Elsevier, vol. 112(1), pages 30-52.
    8. John C. Williams & John B. Taylor, 2009. "A Black Swan in the Money Market," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 58-83, January.
    9. Baba, Naohiko & Packer, Frank, 2009. "From turmoil to crisis: Dislocations in the FX swap market before and after the failure of Lehman Brothers," Journal of International Money and Finance, Elsevier, vol. 28(8), pages 1350-1374, December.
    10. Gefang, Deborah & Koop, Gary & Potter, Simon M., 2011. "Understanding liquidity and credit risks in the financial crisis," Journal of Empirical Finance, Elsevier, vol. 18(5), pages 903-914.
    11. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-367, May.
    12. Goyenko, Ruslan & Subrahmanyam, Avanidhar & Ukhov, Andrey, 2011. "The Term Structure of Bond Market Liquidity and Its Implications for Expected Bond Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(1), pages 111-139, February.
    13. Darrell Duffie, 2012. "Over-The-Counter Markets," Introductory Chapters, in: Dark Markets: Asset Pricing and Information Transmission in Over-the-Counter Markets, Princeton University Press.
    14. Amihud, Yakov & Mendelson, Haim, 1980. "Dealership market : Market-making with inventory," Journal of Financial Economics, Elsevier, vol. 8(1), pages 31-53, March.
    15. Gromb, Denis & Vayanos, Dimitri, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 361-407.
    16. Denis Gromb & Dimitri Vayanos, 2010. "Limits of Arbitrage: The State of the Theory," NBER Working Papers 15821, National Bureau of Economic Research, Inc.
    17. Pesaran M.H. & Schuermann T. & Weiner S.M., 2004. "Modeling Regional Interdependencies Using a Global Error-Correcting Macroeconometric Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 22, pages 129-162, April.
    18. Vayanos, Dimitri, 1998. "Transaction Costs and Asset Prices: A Dynamic Equilibrium Model," The Review of Financial Studies, Society for Financial Studies, vol. 11(1), pages 1-58.
    19. Boudoukh, Jacob & Whitelaw, Robert F, 1993. "Liquidity as a Choice Variable: A Lesson from the Japanese Government Bond Market," The Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 265-292.
    20. Chan, Justin S.P. & Hong, Dong & Subrahmanyam, Marti G., 2008. "A tale of two prices: Liquidity and asset prices in multiple markets," Journal of Banking & Finance, Elsevier, vol. 32(6), pages 947-960, June.
    21. George M. Constantinides, 2005. "Capital Market Equilibrium with Transaction Costs," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 7, pages 207-227, World Scientific Publishing Co. Pte. Ltd..
    22. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    23. Rigobon, Roberto & Sack, Brian, 2004. "The impact of monetary policy on asset prices," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1553-1575, November.
    24. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
    25. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
    26. Ho, Thomas & Stoll, Hans R., 1981. "Optimal dealer pricing under transactions and return uncertainty," Journal of Financial Economics, Elsevier, vol. 9(1), pages 47-73, March.
    27. Tiago Severo, 2012. "Measuring Systemic Liquidity Risk and the Cost of Liquidity Insurance," IMF Working Papers 2012/194, International Monetary Fund.
    28. Huang, Ming, 2003. "Liquidity shocks and equilibrium liquidity premia," Journal of Economic Theory, Elsevier, vol. 109(1), pages 104-129, March.
    29. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, vol. 104(3), pages 425-451.
    30. Refet S Gürkaynak & Brian Sack & Eric Swanson, 2005. "Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements," International Journal of Central Banking, International Journal of Central Banking, vol. 1(1), May.
    31. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
    32. Alexius, Annika & Birenstam, Helene & Eklund, Johanna, 2014. "The interbank market risk premium, central bank interventions, and measures of market liquidity," Journal of International Money and Finance, Elsevier, vol. 48(PA), pages 202-217.
    33. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
    34. Filipović, Damir & Trolle, Anders B., 2013. "The term structure of interbank risk," Journal of Financial Economics, Elsevier, vol. 109(3), pages 707-733.
    35. Lars Norden & Martin Weber, 2009. "The Co†movement of Credit Default Swap, Bond and Stock Markets: an Empirical Analysis," European Financial Management, European Financial Management Association, vol. 15(3), pages 529-562, June.
    36. Paolo Angelini & Andrea Nobili & Cristina Picillo, 2011. "The Interbank Market after August 2007: What Has Changed, and Why?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(5), pages 923-958, August.
    37. Ulrich Bindseil & Kjell G. Nyborg & Ilya A. Strebulaev, 2009. "Repo Auctions and the Market for Liquidity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(7), pages 1391-1421, October.
    38. Roberto Rigobon, 2003. "Identification Through Heteroskedasticity," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 777-792, November.
    39. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
    40. Goyenko, Ruslan Y. & Holden, Craig W. & Trzcinka, Charles A., 2009. "Do liquidity measures measure liquidity?," Journal of Financial Economics, Elsevier, vol. 92(2), pages 153-181, May.
    41. Denis Gromb & Dimitri Vayanos, 2010. "Limits of Arbitrage," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 251-275, December.
    42. Gary Gorton & Andrew Metrick, 2010. "Regulating the Shadow Banking System," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 41(2 (Fall)), pages 261-312.
    43. Tarun Chordia, 2005. "An Empirical Analysis of Stock and Bond Market Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 85-129.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Vayanos, Dimitri & Wang, Jiang, 2013. "Market Liquidity—Theory and Empirical Evidence ," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1289-1361, Elsevier.
    2. Goldstein, Michael A. & Namin, Elmira Shekari, 2023. "Corporate bond liquidity and yield spreads: A review," Research in International Business and Finance, Elsevier, vol. 65(C).
    3. Dimitri Vayanos & Jiang Wang, 2012. "Market Liquidity -- Theory and Empirical Evidence," NBER Working Papers 18251, National Bureau of Economic Research, Inc.
    4. Moinas, Sophie & Nguyen, Minh & Valente, Giorgio, 2017. "Funding Constraints and Market Illiquidity in the European Treasury Bond Market," TSE Working Papers 17-814, Toulouse School of Economics (TSE).
    5. Florackis, Chris & Kontonikas, Alexandros & Kostakis, Alexandros, 2014. "Stock market liquidity and macro-liquidity shocks: Evidence from the 2007–2009 financial crisis," Journal of International Money and Finance, Elsevier, vol. 44(C), pages 97-117.
    6. Alexius, Annika & Birenstam, Helene & Eklund, Johanna, 2014. "The interbank market risk premium, central bank interventions, and measures of market liquidity," Journal of International Money and Finance, Elsevier, vol. 48(PA), pages 202-217.
    7. Florackis, Chris & Kostakis, Alexandros & Kontonikas, Alexandros, 2011. "Transmission of macro-liquidity shocks to liquidity-sorted stock portfolios’ returns: The role of the financial crisis," SIRE Discussion Papers 2011-31, Scottish Institute for Research in Economics (SIRE).
    8. Kurt F. Lewis & Francis A. Longstaff & Lubomir Petrasek, 2017. "Asset Mispricing," NBER Working Papers 23231, National Bureau of Economic Research, Inc.
    9. Lewis, Kurt F. & Longstaff, Francis A. & Petrasek, Lubomir, 2021. "Asset mispricing," Journal of Financial Economics, Elsevier, vol. 141(3), pages 981-1006.
    10. Qin Lei & Xuewu Wang, 2012. "Flight to liquidity due to heterogeneity in investment horizon," China Finance Review International, Emerald Group Publishing, vol. 2(2), pages 316-350, August.
    11. Paolo Pasquariello & Clara Vega, 2015. "Strategic Cross-Trading in the U.S. Stock Market," Review of Finance, European Finance Association, vol. 19(1), pages 229-282.
    12. Nyborg, Kjell G., 2017. "Central bank collateral frameworks," Journal of Banking & Finance, Elsevier, vol. 76(C), pages 198-214.
    13. Lasse Pedersen, 2009. "When Everyone Runs for the Exit," International Journal of Central Banking, International Journal of Central Banking, vol. 5(4), pages 177-199, December.
    14. Andrew Ang & Dimitris Papanikolaou & Mark M. Westerfield, 2014. "Portfolio Choice with Illiquid Assets," Management Science, INFORMS, vol. 60(11), pages 2737-2761, November.
    15. Nyborg, Kjell G., 2017. "Reprint of: Central bank collateral frameworks," Journal of Banking & Finance, Elsevier, vol. 83(C), pages 232-248.
    16. Chris Florackis & Alexandros Kontonikas & Alexandros Kostakis, 2010. "Transmission of macro-liquidity shocks to liquidity-sorted stock portfolios’ returns: The role of the financial crisis," Working Papers 2011_22, Business School - Economics, University of Glasgow, revised Apr 2011.
    17. Boudt, Kris & Paulus, Ellen C.S. & Rosenthal, Dale W.R., 2017. "Funding liquidity, market liquidity and TED spread: A two-regime model," Journal of Empirical Finance, Elsevier, vol. 43(C), pages 143-158.
    18. Vayanos, Dimitri & Wang, Jiang, 2009. "Liquidity and asset prices: a united framework," LSE Research Online Documents on Economics 29303, London School of Economics and Political Science, LSE Library.
    19. Fuhrer, Lucas Marc, 2018. "Liquidity in the repo market," Journal of International Money and Finance, Elsevier, vol. 84(C), pages 1-22.
    20. Ahn, Jungkyu, 2024. "Options illiquidity in an over-the-counter market," International Review of Financial Analysis, Elsevier, vol. 94(C).

    More about this item

    Keywords

    Funding Liquidity; Market Liquidity; Limits of Arbitrage;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ime:imedps:15-e-14. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Kinken (email available below). General contact details of provider: https://edirc.repec.org/data/imegvjp.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.