Regulation of systemic liquidity risk

@article{Cao2010RegulationOS,
  title={Regulation of systemic liquidity risk},
  author={Jin Qiang Cao and Gerhard Illing},
  journal={Financial Markets and Portfolio Management},
  year={2010},
  volume={24},
  pages={31-48}
}
This paper provides a baseline model for regulatory analysis of systemic liquidity shocks. We show that banks may have an incentive to invest excessively in illiquid long-term projects. In the prevailing mixed-strategy equilibrium, the allocation is inferior from the investor’s point of view since some banks free ride on the liquidity provision due to their limited liability. The paper compares different regulatory mechanisms to cope with the externalities. We show that a combination of… CONTINUE READING