The Interaction of Bankers' Asset and Liability Management with Liquidity Concerns

Abstract

This paper develops a dynamic general equilibrium model on the interaction of bankers' asset and liability management with liquidity concerns. Bankers screen real production projects and issue deposits. Liquidity concerns stem from endogenized early withdrawals of deposits. To fulfill early withdrawals, bankers sell assets in a secondary market. The paper argues that ex post asymmetric information in the secondary market distorts bankers' incentive in screening ex ante, as bad assets are easier to sell and generate liquidity benefits. Moreover, the general equilibrium feature of the model implies that exogenous aggregate productivity shocks are amplified and booms may lead to busts.