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Liquidity backstops and dynamic debt runs
Liquidity backstops have important implications for financial stability. In this paper, we provide a microfoundation for the important role of liquidity backstops in mitigating runs (or, conversely, the role of the lack of liquidity backstops in exacerbating runs) based on a dynamic model of debt runs. We focus on the municipal bond markets for variable rate demand obligations (VRDOs) and auction rate securities (ARS). The different experiences in these markets during the recent financial crisis of 2007?09 provide a natural experiment to identify the value of a liquidity backstop in ...