This paper introduces banks into a dynamic stochastic general equilibrium model by featuring asymmetric information as the underlying friction for banking. Asymmetric information about asset qualities causes a lemons problem in the asset market. In this environment, banks can issue liquid liabilities by pooling illiquid assets contaminated by asymmetric information. The liquidity transformation by banks results in a minimum value of common equity that banks must issue to avoid a run. This value increases with downside risk to the asset price and the expected degree of asset illiquidity. It rises during a boom if productivity shocks cause the business cycle.
|Number of pages||27|
|Journal||International Journal of Central Banking|
|Publication status||Published - 2014 Sep 1|
ASJC Scopus subject areas
- Economics and Econometrics