Liquidity Risk and Funding Cost
School of Finance Workingpaper Series
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.
Funding liquidity risk
short-term interest rates
contribution to scientific community
HSG Profile Area
SOF - System-wide Risk in the Financial System