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Cash-in-the-market pricing and optimal bank bailout policy

Subject

Finance

Publishing details

Authors / Editors

Acharya V;Yorulmazer T

Publication Year

2005

Abstract

As the number of bank failures increases, the set of assets available for acquisition by the surviving banks enlarges but the total amount of available liquidity within the surviving bank falls. This results in "cash-in-the-market" pricing for liquidation of banking assets. At a sufficiently large number of bank failures, and in turn, at a sufficiently low level of asset prices, there are too many banks to liquidate and inefficient users of assets who are liquidity-endowed may end owning the liquidated assets. In order to avoid this allocation inefficiency, it may be ex-post optimal for the regulator to bail out some failed banks. Ex-ante, this gives banks an incentive to herd by investing in correlated assets, thereby making aggregate banking crises more likely. These effects are robust to allowing the surviving banks to issue equity and allowing the regulator to price-discriminate against outsiders in the market for bank sales.

Publication Research Centre

Institute of Finance and Accounting

Series Number

FIN 438

Series

IFA Working Paper

Available on ECCH

No


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