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Working Paper
The Welfare Effects of Bank Liquidity and Capital Requirements
The stringency of bank liquidity and capital requirements should depend on their social costs and benefits. This paper investigates their welfare effects and quantifies their welfare costs using sufficient statistics. The special role of banks as liquidity providers is embedded in an otherwise standard general equilibrium growth model. Capital and liquidity requirements mitigate moral hazard from deposit insurance, which, if unchecked, can lead to excessive credit and liquidity risk at banks. However, these regulations are also costly because they reduce the ability of banks to create net ...
Working Paper
Portfolio Choice and Settlement Frictions: A Theory of Endogenous Convenience Yields
We study settlement frictions that arise from the need to finance negative balances through an over-the-counter (OTC) market. We derive a closed-form expression for the endogenous convenience yield and show how it can be incorporated into a canonical portfolio problem. Using this framework, we examine how shifts in settlement frictions affect liquidity premia, the volume of overnight funding, the dispersion of market rates, and optimal portfolio allocations. From a normative perspective, we show that in the competitive equilibrium, investors may either over- or under-invest in liquid assets; ...