Outside And Inside Liquidity

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  • 1 January 2010
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      • Published in RePEc
Abstract
We propose an origination-and-contingent-distribution model of banking, in which liquidity demand by short-term investors can be met with cash reserves (inside liquidity) or sales of assets (outside liquidity) to long-term investors. Outside liquidity is a more efficient source, but asymmetric information about asset quality can introduce a friction in the form of excessively early asset trading in anticipation of a liquidity shock, excessively high cash reserves, and too little origination of assets by banks. The model captures elements of the current financial crisis and yields policy prescriptions on public liquidity provision to overcome liquidity crises.
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