Jan Wrampelmeyer

We propose and test a new channel that links funding liquidity risk and interest rates in short-term funding markets. Unlike existing theories that focus on premiums demanded by lenders, the funding liquidity risk channel postulates that borrowers exposed to liquidity shocks 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 idiosyncratic liquidity risk. These differences are persistent over a decade, suggesting that the funding liquidity risk channel is relevant in general and not only arises during crisis times.

We study how individual banks borrow and lend in the euro unsecured and secured interbank market. We find that banks with lower credit worthiness replace unsecured with secured borrowing, which is consistent with a reduction in the supply of unsecured loans rather than a lower demand for funding. Riskier lenders replace unsecured with secured lending, suggesting that banks take precautionary measures and prefer to lend against safe collateral. Our results highlight the importance of a joint analysis of unsecured and secured funding. Separate analyses only give a partial view and might yield misleading conclusions when banks access both funding sources.

The search for a market design that ensures stable bank funding is at the top of regulators' policy agenda. This paper empirically shows that the central counterparty (CCP)-based euro interbank repo market features this stability. Using a unique and comprehensive data set, we show that the market is resilient during crisis episodes and may even act as a shock absorber, in the sense that repo lending increases with risk, while spreads, maturities, and haircuts remain stable. Our comparison across different repo markets shows that anonymous CCP-based trading, safe collateral, and the absence of an unwind mechanism are the key characteristics to ensure market resilience

We provide the first systematic study of liquidity in the foreign exchange market. We find significant variation in liquidity across exchange rates, substantial illiquidity costs, and strong commonality in liquidity across currencies and with equity and bond markets. We analyze the impact of liquidity risk on carry trades, a popular trading strategy that borrows in low-yielding currencies and invests in high-yielding currencies. Results show that funding (investment) currencies offer insurance against (exposure to) liquidity risk. A liquidity risk factor has a strong impact on carry trade returns from 2007 to 2009, suggesting that liquidity risk is priced. We present evidence that liquidity spirals may trigger these findings.

Hedge funds are frequently blamed for increasing volatility and illiquidity in financial markets. The author investigates the validity of this hypothesis by modeling the joint dynamics of hedge fund returns and volatility as well as illiquidity in the equity and the foreign exchange (FX) market. The results show that hedge funds tend to profit from periods of low equity liquidity but react negatively to shocks in volatility and FX illiquidity, indicating a significant FX exposure for many strategies. The author finds only weak evidence that hedge funds' speculative trading causes higher volatility in financial markets. However, the perceived detrimental effect of hedge fund activity on financial markets can be explained by exposure to (alternative) risk factors which are correlated to volatility and illiquidity. Finally, there exist cross-market dynamics and bidirectional spillovers between volatility and illiquidity in the equity and FX market. These results have important implications for performance attribution and risk management, as well as regulatory policy.

We provide the first joint analysis of the secured and unsecured money markets of the euro area using bank-level data. After the Lehman crisis, two important substitution mechanisms emerge: banks with higher credit risk offset reductions of unsecured borrowing with secured funding. Riskier banks replace unsecured lending by granting more secured loans. However, high leverage and reliance on short-term funding hamper banks' ability to substitute. Moreover, banks enduring money market strains contribute to the credit crunch. Overall, our findings suggest that the secured segment of the euro money market contributes to financial stability, mitigating systemic effects such as short-term funding strains and contagion.

The search for a market design that ensures stable bank funding is at the top of regulators' policy agenda. This paper empirically shows that the central counterparty (CCP)-based euro interbank repo market features this stability. Using a unique and comprehensive data set, we show that the market is resilient during crisis episodes and may even act as a shock absorber, in the sense that repo lending increases with risk, while spreads, maturities, and haircuts remain stable. Our comparison across different repo markets shows that anonymous CCP-based trading, safe collateral, and the absence of an unwind mechanism are the key characteristics to ensure market resilience.

We provide the first comprehensive theoretical model for money markets encompassing unsecured and secured funding, asset markets, and central bank policy. In our model, leveraged banks invest in assets and raise short-term funds by borrowing in the unsecured and secured money markets. We derive how funding liquidity across money markets is related, explain how a shock to asset values can lead to mutually reinforcing liquidity spirals in both money markets, and show how borrowers' right-to-safety and risk-seeking behavior impacts their liability structure. We derive the socially optimal leverage ratio and funding structure, and show which combination of conventional and unconventional monetary policies and regulatory measures can reduce money market fragility.

We provide the first comprehensive theoretical model for money markets encompassing unsecured and secured funding, asset markets, and central bank policy. In our model, leveraged banks invest in assets and raise short-term funds by borrowing in the unsecured and secured money markets. We derive how funding liquidity across money markets is related, explain how a shock to asset values can lead to mutually reinforcing liquidity spirals in both money markets, and show how borrowers' right-to-safety and risk-seeking behavior impacts their liability structure. We derive the socially optimal leverage ratio and funding structure, and show which combination of conventional and unconventional monetary policies and regulatory measures can reduce money market fragility.