A MODEL OF FINANCIAL MARKET LIQUIDITY BASED ON INTERMEDIARY CAPITAL

Authors


denis.gromb@insead.edu

d.vayanos@lse.ac.uk

Abstract

We present a model of financial market liquidity provided by financially constrained intermediaries. We show that market liquidity increases with the level of intermediary capital. We also characterize conditions under which intermediaries play a stabilizing or destabilizing role in markets. Finally, we sketch a number of areas, including welfare and public policy, on which the model can shed light. (JEL: G01, G11, G12, G15, G18)

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