Balancing Liquidity and Returns through Interbank Markets: Endogenous Interest Rates and Network Structures

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Abstract

In this article, we develop a model of interbank lending based on liquidity and return on equity considerations of homogeneous banks. We derive the reservation prices of interbank lending and its properties before exploring how, because of an idiosyncratic liquidity shock, banks engage in bilateral lending to form an interbank network. We establish that the resulting networks exhibit realistic properties, including a core-periphery structure. Banks in the core and the periphery of this network differ not only in the amounts of interbank lending and borrowing but also in the interest rates applied to their transactions.

Original languageEnglish
Pages (from-to)131-149
JournalJournal Of Financial Research
Volume46
Issue number1
Early online date6 Oct 2022
DOIs
Publication statusPublished - 31 Mar 2023

Bibliographical note

Funding Information:
This work was supported by the National Natural Science Foundation of China (72001022) and the Humanities and Social Sciences Foundation of Ministry of Education of China (20YJCZH184).

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