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Abstract We provide a model that links a assets' market liquidity -i.e., the ease of trading it -and traders' funding liquidity -i.e., their availability of funds. Traders provide market liquidity and their ability to do so depends on their funding. Conversely, traders' funding, i.e., their capital and the margins they are charged, depend on the assets' market liquidity. We show that under certain conditions margins are destabilizing and market liquidity and funding liquidity are mutually reinforcing, leading to liquidity spirals. The model explains the empirically documented features that market liquidity (i) is fragile, i.e. can suddenly dry up, (ii) has commonality across securities, (iii) is related to volatility, (iv) experiences "flight to liquidity" events, and (v) comoves with the market.

During the past 20 years, the world’s major central banks have been largely successful at bringing inflation under control. Although it is premature to suggest that inflation is no longer an issue of great concern, it is quite conceivable that the next battles facing central bankers will lie on a different front. One development that has already concentrated the minds of policymakers is an apparent increase in financial instability, of which one important dimension is increased volatility of asset prices. Borio, Kennedy, and Prowse (1994), among others, document the emergence of major boom-bust cycles in the prices of equity and real estate in a number of industrialized countries during the 1980s. Notable examples include the United States,

We propose a multiperiod model in which competitive arbitrageurs exploit discrepancies between the prices of two identical risky assets traded in segmented markets. Arbitrageurs need to collateralize separately their positions in each asset, and this implies a financial constraint limiting positions as a function of wealth. In our model, arbitrage activity benefits all investors because arbitrageurs supply liquidity to the market. However, arbitrageurs might fail to take a socially optimal level of risk, in the sense that a change in their positions can make all investors better off. We characterize conditions under which arbitrageurs take too muchor too little risk.

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Abstract We develop a quantitative monetary DSGE model with …nancial intermediaries that face endogenously determined balance sheet constraints. We then use the model to evaluate the e¤ects of the central bank using unconventional monetary policy to combat a simulated …nancial crisis. We interpret unconventional monetary policy as expanding central bank credit intermediation to o¤set a disruption of private …nancial intermediation. Within our framework the central bank is less e¢ cient than private intermediaries at making loans but it has advantage of being able to elastically obtain funds by issuing riskless government debt. Unlike private intermediaries, it is not balance-sheet constrained. During a crisis, the balance sheet constraints on private intermediaries tighten, raising the net bene…ts from central bank intermediation. These bene…ts may be substantial even if the zero lower bound constraint on the nominal interest rate is not binding. In the event this constraint is binding, though, these net bene…ts may be signi…cantly enhanced. Much thanks to Bob Hall and Hal Cole for comments on an earlier draft and to Luca Guerrieri for computational help.

We develop a canonical framework to think about credit market frictions and aggregate economic activity in the context of the current crisis. We use the framework to address two issues in particular: first, how disruptions in financial intermediation can induce a crisis that affects real activity; and second, how various credit market interventions by the central bank and the Treasury of the type we have seen recently, might work to mitigate the crisis. We make use of earlier literature to develop our framework and characterize how very recent literature is incorporating insights from the crisis.

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This paper provides new evidence of how macroeconomic conditions affect capital structure choice. We model firms ’ target capital structures as a function of macroeconomic conditions and firm-specific variables. We split our sample based on a measure of financial constraints. We find that target leverage is counter-cyclical for the relativelyunconstrained sample, but pro-cyclical for the relativelyconstrained sample. The choice of what type of security to issue/repurchase is significantly related to deviations from the target capital structure, particularly for the constrained sample. Macroeconomic conditions are significant for issue choice for unconstrained firms but less so for constrained firms. Our results support the hypothesis that unconstrained firms are able to time their issue choice to periods when macroeconomic conditions are favorable, while constrained firms take what they can get.