A modelofliquidityhoardingandtermpremiain inter-bankmarkets

Financialcrisesareassociatedwithreducedvolumesandextremelevelsofratesfor terminter-bankloans,reflectedinone-monthandthree-monthLIBOR.Weexplainsuch stress bymodelingleveragedbanks’precautionarydemandforliquidity.Assetshocks impairabank’sabilitytorolloverdebtbecauseofagencyproblemsassociatedwith high leverage.Inturn,bankshoardliquidityanddecreasetermlendingastheirrollover risk increasesoverthetermoftheloan.Highlevelsofshort-termleverageand illiquidityofassetsleadtolowvolumesandhighratesfortermborrowing.Inextremis, inter-bankmarketscancompletelyfreeze