Review of Finance Vol. 27 No. 2 2023

Liquidity Risk and Funding Cost

Alexander Bechtel¹; Angelo Ranaldo¹; Jan Wrampelmeyer^2,3

¹ University of St. Gallen , St. Gallen and Swiss Finance Institute, · ² VU Amsterdam , Amsterdam, · ³ Tinbergen Institute , Amsterdam,

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.

DOI

10.1093/rof/rfac020

Volume

27

Issue

2

Pages

399-422

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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