Money and Liquidity in Financial Markets

We argue that there is a connection between the interbank market for liquidity and thebroader financial markets, which has its basis in demand for liquidity by banks. Tightnessin the interbank market for liquidity leads banks to engage in what we term “liquiditypull-back,” which involves selling financial assets either by banks directly or by leveredinvestors. Empirical tests support this hypothesis. While our data covers part of therecent crisis period, our results are not driven by the crisis. Our general point is thatmoney matters in financial markets.[...]