Spanjers, Willem (2011) Liquidity provision, ambiguous asset returns and the financial crisis. (Working Paper) Freiburg, Germany : University of Freiburg. 40 p. (RCEA Working Papers, no. 11-10)
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Abstract
In a setting similar to Allen and Gale (1998), the optimal liquidity provision is analyzed for illiquid assets subjected to incalculable risk (i.e. ambiguity). We consider the ex-ante second best liquidity allocation, an ad interim asset market, and a competitive banking sector. If investors know imminent banking panics trigger appropriate regulatory intervention, a competitive banking sector implements the second best outcome. Ambiguity leads to dynamic inconsistency in investor behaviour. If banks mis-interpret the ambiguity, unanticipated fundamental bank runs may occur, which they incorrectly blame on investors 'loosing their nerves' and 'panicing'. The fundamental mechanism of the financial crisis resembles a banking panic in the presence of ambiguous asset returns. The combination of providing additional liquidity and supporting distressed banks effectively implements the regulatory policy suggested for the model. A credible commitment to such 'bail-out-policy' does not create a moral hazard problem. Rather, is implements the second best efficient outcome by discouraging excessive caution. Reducing ambiguity by increasing stability, transparency, and predictability - as suggested by ordo-liberalism and the 'Freiburger Schule' - enhances ex-ante welfare.
| Item Type: | Monograph (Working Paper) |
|---|---|
| Event Title: | Does not apply |
| Uncontrolled Keywords: | financial intermediation, liquidity, ambiguity, choquet expected utility, financial crisis |
| Research Area: | Accounting and finance Economics and econometrics |
| Faculty, School or Research Centre: | Faculty of Arts and Social Sciences > School of Economics (until November 2012) |
| Depositing User: | Willem Spanjers |
| Date Deposited: | 15 Oct 2012 14:09 |
| Last Modified: | 15 Oct 2012 14:09 |
| URI: | http://eprints.kingston.ac.uk/id/eprint/21878 |
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Liquidity provision, ambiguous asset returns and the financial crisis. (deposited 17 May 2010 08:41)
- Liquidity provision, ambiguous asset returns and the financial crisis. (deposited 15 Oct 2012 14:09) [Currently Displayed]
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