Arbeitspapier

On the role of market makers for money market liquidity and tensions

We analyze the trading book of a key market maker in the European unsecured money market and study the extent to which liquidity risks accumulated by this market maker affect his pricing of liquidity and the bid/ask spread he quotes on unsecured borrowing and lending. We find that the larger the funding liquidity risk assumed by the market maker is, the higher the market price for liquidity. Furthermore, his bid/ask spread and the sensitivity of his bid/ask spread to the maturity of the transaction increases as his assumed liquidity risk rises. Our findings have two important implications: First, we document that the funding constraints and funding risks of market makers affect market liquidity in line with Gromp and Vayanos (2004) and Brunnermeier and Pedersen (2009) also in the unsecured money market. Second, we document that the retained liquidity risks of money market makers led to an economically significant rise in the unsecured to secured money market rates and contributed to the dry-up of this market in 2007/2008.

Language
Englisch

Bibliographic citation
Series: Kiel Working Paper ; No. 2013

Classification
Wirtschaft
Financial Crises
General Financial Markets: General (includes Measurement and Data)
Banks; Depository Institutions; Micro Finance Institutions; Mortgages
Subject
Funding liquidity risk and money market liquidity
Liquidity constraints
Money market makers
Liquidity spirals

Event
Geistige Schöpfung
(who)
Fecht, Falko
Reitz, Stefan
Weber, Patrick
Event
Veröffentlichung
(who)
Kiel Institute for the World Economy (IfW)
(where)
Kiel
(when)
2015

Handle
Last update
10.03.2025, 11:41 AM CET

Data provider

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Object type

  • Arbeitspapier

Associated

  • Fecht, Falko
  • Reitz, Stefan
  • Weber, Patrick
  • Kiel Institute for the World Economy (IfW)

Time of origin

  • 2015

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