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September 2014 issue
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Hördahl, Tistani
Nakov, Thomas
Kelly, McQuinn
Aizenman, Glick
Arrondel, Savignac, Tracol
Cecchetti, Kohler
Bauer, Rudebusch
Tomura
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Asset Illiquidity and Dynamic Bank Capital Requirements

by Hajime Tomura
University of Tokyo

Abstract

This paper introduces banks into a dynamic stochastic general equilibrium model by featuring asymmetric information as the underlying friction for banking. Asymmetric information about asset qualities causes a lemons problem in the asset market. In this environment, banks can issue liquid liabilities by pooling illiquid assets contaminated by asymmetric information. The liquidity transformation by banks results in a minimum value of common equity that banks must issue to avoid a run. This value increases with downside risk to the asset price and the expected degree of asset illiquidity. It rises during a boom if productivity shocks cause the business cycle.

JEL Codes: E44, G21, D82.

 
Full article (PDF, 27 pages, 361 kb)
Appendices (PDF, 19 pages, 275 kb)