Leaning Against the Wind

Pierre-Olivier Weill
Publication Type: 
Papers
Publication Article File: 
Journal Name: 
The Review of Economic Studies
Journal Volume: 
74
Pages: 
1329-1354
Publication Year: 
2007

During financial disruptions, marketmakers provide liquidity by absorbing external selling pressure. They buy when the pressure is large, accumulate inventories, and sell when the pressure alleviates. This paper studies optimal dynamic liquidity provision in a theoretical market setting with large and temporary selling pressure, and order-execution delays. I show that competitive marketmakers offer the socially optimal amount of liquidity, provided they have access to sufficient capital. If raising capital is costly, this suggests a policy role for lenient central-bank lending during financial disruptions.

This paper was presented at the Optimal Design of Payments Systems Workshop in May of 2011.

Region: 
Global
Country: 
Global
Topic: 
Regulation
Topic: 
Payments Systems