Liquidity Risk and Funding Cost

Alexander Bechtel; Angelo Ranaldo; Jan Wrampelmeyer

doi:10.1093/rof/rfac020

Liquidity Risk and Funding Cost

Alexander Bechtel, Angelo Ranaldo, Jan Wrampelmeyer

Research output: Contribution to Journal › Article › Academic › peer-review

Abstract

We propose and test a new channel that links liquidity risk and interest rates in short-term funding markets. Unlike existing theories that focus on premiums demanded by lenders, the liquidity risk channel postulates that borrowers that are more exposed to urgent liquidity needs are willing to pay a markup for immediate funding. We test and quantify the channel using unique trade-by-trade data and uncover systematic differences across individual banks' funding cost driven by differences in banks' liquidity risk. These differences are persistent over a decade, suggesting that the liquidity risk channel is relevant in general and not only arises during crisis times.

Original language	English
Pages (from-to)	399-422
Number of pages	24
Journal	Review of Finance
Volume	27
Issue number	2
DOIs	https://doi.org/10.1093/rof/rfac020
Publication status	Published - Mar 2023

Bibliographical note

Funding Information:
We are grateful to Christine Parlour (the editor) and one anonymous referee. Additionally, we thank Christoph Aymanns, Martin Brown, Matthias Fleckenstein, Thierry Foucault, Florian Heider, Friederike Kliem, Iman van Lelyveld, Dan Li, Albert Menkveld, Kleopatra Nikolaou, Benoît Nguyen, Loriana Pelizzon, Ilaria Piatti, Jean-Paul Renne, Günseli Tümer-Alkan, Guillaume Vuillemey, and the participants of the 17th Paris December Finance Meeting 2019, EFA Annual Meeting 2019, the 2nd Short-Term Funding Markets Conference 2019, the 2019 Conference on Financial Intermediation in a Globalized World at the Deutsche Bundesbank, the 2018 Annual Central Bank Conference on the Microstructure of Financial Markets, the ECB workshop on money markets, monetary policy implementation and central bank balance sheets 2018, the 24th CEF conference 2018, as well as of research seminars at De Nederlandsche Bank, Frankfurt School of Finance and Management, University of Bristol, University of Hannover, University of Stavanger, University of Southern Denmark, and University of St. Gallen for helpful comments. We gratefully acknowledge financial support from the Fondation Banque de France and the Sinergia grant 154445 of the Swiss National Science Foundation.

Publisher Copyright:
© The Author(s) 2022. Published by Oxford University Press on behalf of the European Finance Association.

Keywords

Funding cost
Funding liquidity
Interbank market
Risk premiums
Short-term interest rates

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title = "Liquidity Risk and Funding Cost",

abstract = "We propose and test a new channel that links liquidity risk and interest rates in short-term funding markets. Unlike existing theories that focus on premiums demanded by lenders, the liquidity risk channel postulates that borrowers that are more exposed to urgent liquidity needs are willing to pay a markup for immediate funding. We test and quantify the channel using unique trade-by-trade data and uncover systematic differences across individual banks' funding cost driven by differences in banks' liquidity risk. These differences are persistent over a decade, suggesting that the liquidity risk channel is relevant in general and not only arises during crisis times.",

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AB - We propose and test a new channel that links liquidity risk and interest rates in short-term funding markets. Unlike existing theories that focus on premiums demanded by lenders, the liquidity risk channel postulates that borrowers that are more exposed to urgent liquidity needs are willing to pay a markup for immediate funding. We test and quantify the channel using unique trade-by-trade data and uncover systematic differences across individual banks' funding cost driven by differences in banks' liquidity risk. These differences are persistent over a decade, suggesting that the liquidity risk channel is relevant in general and not only arises during crisis times.

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Liquidity Risk and Funding Cost

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Keywords

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