Measuring Liquidity Mismatch in the Banking Sector

Measuring Liquidity Mismatch in the Banking Sector

  • JENNIE BAI
  • ARVIND KRISHNAMURTHY
  • CHARLES‐HENRI WEYMULLER

Article first published online: 12th October 2017 DOI: 10.1111/jofi.12591

Abstract


This paper constructs a Liquidity Mismatch Index (LMI) to gauge the mismatch between the market liquidity of assets and the funding liquidity of liabilities, for 2882 bank holding companies over 2002 to 2014. The aggregate LMI decreases from +$4 trillion pre‐crisis to ‐$6 trillion in 2008. We conduct an LMI stress test revealing the fragility of the banking system in early 2007. Moreover, LMI predicts a bank’s stock market crash probability and borrowing decisions from the government during the financial crisis. The LMI is therefore informative about both individual bank liquidity and the liquidity risk of the entire banking system.

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