Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation

RePEc Short ID: ppr11
ORCID iD: 0000-0002-6433-1680

Davis, Douglas; Korenok, Oleg; Lightle, John; Prescott, Edward Simpson

doi:10.26509/frbc-wp-201810

Working Paper

Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation

Abstract: We develop a stylized interbank market environment and use it to evaluate with experimental methods the effects of liquidity requirements. Baseline and liquidity-regulated regimes are analyzed in a simple shock environment, which features a single idiosyncratic shock, and in a compound shock environment, in which the idiosyncratic shock is followed by a randomly occurring second-stage shock. Interbank trading of the illiquid asset follows each shock. In the simple shock environment, we find that liquidity regulations reduce the incidence of bankruptcies, but at a large loss of investment efficiency. In the compound shock environment, liquidity regulations not only impose a loss of investment efficiency but also fail to reduce bankruptcies.

Keywords: Interbank market; liquidity regulations; market experiments; ;

JEL Classification: C9; G21;

https://doi.org/10.26509/frbc-wp-201810