Falko Fecht

Financial Intermediaries, Markets, and Growth

We build a model in which financial intermediaries provide insurance to households against a liquidity shock. Households can also invest directly on a financial market if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. This can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. Our model predicts that bank-oriented economies should grow slower than more market-oriented economies, which is consistent with some recent empirical evidence. We show that the mix of intermediaries and market that maximizes welfare under a given level of financial development depends on economic fundamentals. We also show the optimal mix of two structurally very similar economies can be very different.

The Price of Liquidity: Bank Characteristics and Market Conditions

We identify frictions in the market for liquidity as well as bank-specific and market-wide factors that affect the prices that banks pay for liquidity, captured here by borrowing rates in repos with the central bank and benchmarked by the overnight index swap. We have price data at the individual bank level and, unique to this paper, data on individual banks’ reserve requirements and actual reserve holdings, thus allowing us to gauge the extent to which a bank is short or long liquidity. We find that the price a bank pays for liquidity depends on the liquidity positions of other banks, as well as its own. There is evidence that liquidity squeezes occasionally occur and short banks pay more the larger is the potential for a squeeze. The price paid for liquidity is decreasing in bank size and small banks are more adversely affected by an increased potential for a squeeze. Healthier banks pay less, but contrary to what one might expect, banks in formal liquidity networks do not.

The Dark and the Bright Side of Liquidity Risks: Evidence from Open-End Real Estate Funds in Germany

We use a unique and comprehensive data set on open-end real estate funds in Germany to study a liquidity crisis that hit this industry between 2005 and 2006. Since this industry is comparably unregulated our data set permits us to contrast competing explanations of liquidity crisis. We find that fundamental factors matter for the liquidity outflow in normal times. During the crisis, however, they do not play a role. During the panic only strategic complementarities drive withdrawals. Furthermore, we find that funds with a higher load fee suffer from substantially larger outflows in the crisis period, while a higher load fee reduces gross outflows in normal times. As institutional investors predominately invest in funds with a low load fee this is in line with recent theory arguing that complementarities are mitigated by the involvement of large institutional investors who can at least partially correct for the coordination failure resulting from complementarities.

Cross-Border Liquidity, Relationships and Monetary Policy: Evidence from the Euro Area Interbank Crisis

We analyze the impact of financial crises and monetary policy on the supply of wholesale funding liquidity, and also on the compositional supply effects through cross-border and relationship lending. For empirical identification, we draw on the proprietary bank-to-bank European interbank dataset extracted from Target2 and also exploit the Lehman and sovereign crisis shocks as well as the main Eurosystem non-standard monetary policy measures. The robust results imply that the crisis shocks lead to worse access, volumes and spreads (in both the overnight and longer-term maturities). The quantitative impact on interbank access and volume is stronger than on spreads. Liquidity supply restrictions are exacerbated for cross-border lending after the Lehman failure; for banks headquartered in periphery countries, the impact is quantitatively stronger in the sovereign debt crisis. Moreover, the interbank market – unlike other credit markets – allows to exploit the price dispersion from different lenders on identical credit contracts, i.e. overnight uncollateralized loans in the same morning for the same borrower. This price dispersion increases massively with the crisis, and even more for riskier borrowers. Cross-border and previous relationship lenders charge higher prices for identical contracts in the crisis. Importantly, this price dispersion substantially decreases when the Eurosystem promises unlimited access to liquidity at a fixed price in October 2008 and announces the 3-year LTRO in December 2011, with economically stronger effects for borrowers in weaker countries.

Is Proprietary Trading Detrimental to Retail Investors

We study a conflict of interest faced by universal banks that conduct proprietary trading alongside their retail banking services. Our dataset contains the stock holdings of each and every German bank and of their corresponding retail clients. We investigate (i) whether banks deliberately push stocks from their proprietary portfolios into their retail customer portfolios, (ii) whether those stocks subsequently underperform, and (iii) whether retail customers of banks with proprietary trading earn lower long-term portfolio returns than their peers. We present affirmative evidence on all three questions and conclude that proprietary trading can, in fact, be very detrimental to retail investors.

Corporate Transparency and Bond Liquidity

To answer the question what causes an asset to be illiquid, we analyze the impact that transparency of corporate accounting information has on the liquidity of its traded bonds. In particular, we focus on how this relationship depends on aggregate liquidity and the financial state of the firm. We use an extensive panel data set comprising more than 40,000 quarterly bond observations between 2004Q4 and 2012Q4. We find a statistically and economically significant impact of transparency on bond liquidity. This relationship becomes stronger during times of financial distress. We also find that the impact of transparency on liquidity is much larger than the influence of credit risk. Finally, we also find that transparent accounting information has a strong effect on liquidity risk.

Is Proprietary Trading Detrimental to Retail Investors?: Is Proprietary Trading Detrimental to Retail Investors?

We study a conflict of interest faced by universal banks that conduct proprietary trading alongside their retail banking services. Our dataset contains the stock holdings of each and every German bank and of their corresponding retail clients. We investigate (i) whether banks deliberately push stocks from their proprietary portfolios into their retail customer portfolios, (ii) whether those stocks subsequently underperform, and (iii) whether retail customers of banks with proprietary trading earn lower long-term portfolio returns than their peers. We present affirmative evidence on all three questions and conclude that proprietary trading can, in fact, be very detrimental to retail investors.

Dealer behaviour in the Euro money market during times of crisis

ABSTRACT This article shows how the recent money market disruptions with elevated counterparty risks and uncertainty about the fundamental value of liquidity influenced the trading behaviour of a key dealer in the Euro money market. The complete trading record in the unsecured segment of the money market for 2007 and 2008 is used to estimate a stylized pricing model, which explicitly accounts for the over-the-counter structure. The empirical results suggest that the market maker learns from order flow, but this information aggregation was increasingly hampered as the crisis unfolded.