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Strategic Allocation of Liquidity in the InterBank Money Market

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  • Mallick, Indrajit

Abstract

ABSTRACT This paper focuses on an ex post trading problem in inter-bank money markets. An “over the counter” inter-bank market is modeled in this paper. Relationship banking leads to private proprietary information that causes bargaining failure in such markets with positive probability. Both independent and interdependent bargaining games are studied. It is shown that the allocation is not constrained efficient under bargaining games without monetary intervention. Monetary intervention is characterized as state contingent market making by the Central Bank. Such intervention is shown to dominate under a variety of informational and bargaining assumptions. The literature on monetary policy design is thus extended in the present paper by providing a micro-rationale for Central Bank intervention and by characterizing the solution of state contingent market making in liquidity.

Suggested Citation

  • Mallick, Indrajit, 2004. "Strategic Allocation of Liquidity in the InterBank Money Market," MPRA Paper 15427, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:15427
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    File URL: https://mpra.ub.uni-muenchen.de/15427/1/MPRA_paper_15427.pdf
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    References listed on IDEAS

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    1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    2. Martin J. Osborne & Ariel Rubinstein, 2005. "Bargaining and Markets," Levine's Bibliography 666156000000000515, UCLA Department of Economics.
    3. Bhattacharya, Sudipto & Padilla, A Jorge, 1996. "Dynamic Banking: A Reconsideration," The Review of Financial Studies, Society for Financial Studies, vol. 9(3), pages 1003-1032.
    4. Jean-Charles Rochet & Jean Tirole, 1996. "Interbank lending and systemic risk," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 733-765.
    5. Freixas, Xavier & Parigi, Bruno, 1998. "Contagion and Efficiency in Gross and Net Interbank Payment Systems," Journal of Financial Intermediation, Elsevier, vol. 7(1), pages 3-31, January.
    6. Mallick, Indrajit, 2004. "Inefficiency of bilateral bargaining in interbank markets," International Review of Economics & Finance, Elsevier, vol. 13(1), pages 43-55.
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    Cited by:

    1. Vollmer, Uwe & Wiese, Harald, 2014. "Explaining breakdowns in interbank lending: A bilateral bargaining model," Finance Research Letters, Elsevier, vol. 11(3), pages 247-253.

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    More about this item

    Keywords

    KEY WORDS Liquidity; Incomplete Information; Bargaining Failure; Central Bank; Monetary Intervention; Market Making;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • G0 - Financial Economics - - General

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