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- W2912762938 abstract "Trading firms, whom we entrust the job of providing liquidity, may exacerbate liquidity shocks to the economy and furthermore, reduce efficacy of liquidity injections by the state. In addition, as ample evidence in the recent crisis shows, trading firms observe their losses privately and have incentives to avoid revealing losses due to the fear of a bank run by investors and counter-parties. Hence, even if central banks stand ready to guarantee liquidity, due to the pooling behaviour of trading firms, liquidity allocation will be inefficient. This prolongs the liquidity crisis, as firms in red use injected liquidity to stave off bank runs, while other firms may use new liquidity to take predatory positions. Hence, we suggest a different approach in this paper: to avoid the pooling equilibrium between firms in black and in red, a separating equilibrium is encouraged where all the liquidity is provided to firms with stronger balance sheets, allowing them to absorb the assets of the firms facing losses. As the firms with better books compete against each other with new found liquidity, and the firms in red exit, the liquidity in capital markets also improves quickly. We also show that banks taking higher leverage and specializing in certain financial instruments is a robust equilibrium and is useful for minimizing costs of financing." @default.
- W2912762938 created "2019-02-21" @default.
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- W2912762938 date "2009-01-01" @default.
- W2912762938 modified "2023-10-03" @default.
- W2912762938 title "Quis Custodiet Ipsos Custodes?" @default.
- W2912762938 doi "https://doi.org/10.2139/ssrn.1343754" @default.
- W2912762938 hasPublicationYear "2009" @default.
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