Financial Market Liquidity and the Lender of Last Resort.

It has been argued in the literature that emergency liquidity injections should be conducted preferably in the form of open market operations. As we show in the present paper, this is not necessarily the case when liquidity may be alternatively used for speculative purposes during the crisis. In such a situation, non-discriminating operations may attract unfunded market participants that divert funding resources away from its best uses in the financial sector. As a consequence, targeted liquidity assistance may become strictly superior. The analysis might have a bearing on recent developments in the context of the subprime crisis.Liquidity ; Financial markets ; Lender of last resort.

Financial market liquidity and the lender of last resort.

In the summer 2007, difficulties in the US subprime mortgage markets have led to disruptive developments in many financial market segments, in particular in interbank money markets, where central banks in the US and in Europe repeatedly intervened to restore smooth market functioning. This article investigates the circumstances in which liquidity shortages may appear in fi nancial markets and evaluates a number of options available to the lender of last resort wishing to restore fi nancial stability. It also suggests that the consideration of balance sheet data is not sufficient for evaluating the risks of leveraged financial entities. Instead, the analysis calls for an explicit consideration of collateral pledges, market illiquidity, and potential non-availability of market prices. Our main messages can be summarised as follows. First, we provide a clear hierarchy across policy alternatives. Taking a risk-efficiency perspective, it turns out that targeted liquidity assistance is preferable to market-wide non-discriminatory liquidity injections. In particular, when liquidity may be alternatively used for speculative purposes during the crisis, non-discriminating open market operations may attract unfunded market participants that divert funding resources away from its best uses in the financial sector. As a consequence, targeted liquidity assistance may become strictly superior. Second, we suggest that forced asset sales may lead to disruptive market developments in a context where financial investors are highly leveraged. Assuming away external funding or renegociability of debt contracts, a fully leveraged investor hit by a liquidity shock would have to liquidate some assets. When markets are not perfectly liquid, asset liquidation depresses market prices. Under standard risk management constraints, lower prices induce a re-evaluation of marked-to-market balance sheets, provoke margin calls, and trigger further selling. In the worst scenario, the leveraged investor may not be able to face the sum of liquidity outfl ows and subsequent margin calls. In that case, the market for illiquid assets breaks down, rendering the valuation of such assets an ambiguous exercise. For investors, such potential trading disruptions imply that the loss that triggers operational default is likely to be much smaller than suggested by standard risk measures.

Forced Portfolio Liquidation.

We study the problem of a leveraged investor that is forced to unwind a significant fraction of its portfolio in a collection of illiquid markets. It is shown that markets may become disrupted in response to a relatively small liquidity shock. As a consequence, the probability of default can be much higher than suggested by standard risk measures. We also study the impact of successful liquidation on relative asset prices. Our analysis suggests that effective risk management of leveraged financial entities should focus on the entity's potential to generate emergency cash-flows net of third-party claims for liquidity.Portfolio liquidation ; Market disruption ; Leverage ; Determinants of asset liquidity ; Hedge funds ; Structured credit.

Charge order, metallic behavior and superconductivity in La_{2-x}Ba_xCuO_4 with x=1/8

The ab-plane optical properties of a cleaved single crystal of La_{2-x}Ba_xCuO_4 for x=1/8 (T_c ~ 2.4 K) have been measured over a wide frequency and temperature range. The low-frequency conductivity is Drude-like and shows a metallic response with decreasing temperature. However, below ~ 60 K, corresponding to the onset of charge-stripe order, there is a rapid loss of spectral weight below about 40 meV. The gapping of single-particle excitations looks surprisingly similar to that observed in superconducting La_{2-x}Sr_{x}CuO_4, including the presence of a residual Drude peak with reduced weight; the main difference is that the lost spectral weight moves to high, rather than zero, frequency, reflecting the absence of a bulk superconducting condensate.Comment: 4 pages, with 1 table and 3 figure

The Ground State of the Pseudogap in Cuprate Superconductors

We present studies of the electronic structure of La2-xBaxCuO4, a system where the superconductivity is strongly suppressed as static spin and charge orders or "stripes" develop near the doping level of x=1/8. Using angle-resolved photoemission and scanning tunneling microscopy, we detect an energy gap at the Fermi surface with magnitude consistent with d-wave symmetry and with linear density of states, vanishing only at four nodal points, even when superconductivity disappears at x=1/8. Thus, the non-superconducting, "striped" state at x=1/8 is consistent with a phase incoherent d-wave superconductor whose Cooper pairs form spin/charge ordered structures instead of becoming superconducting.Comment: This is the author's version of the wor

Doping of a One-Dimensional Mott Insulator: Photoemision and Optical Studies of Sr2_2CuO3+δ_{3+\delta}

The spectral properties of a one-dimensional (1D) single-chain Mott insulator Sr$_2$CuO$_{3}$ have been studied in angle-resolved photoemission and optical spectroscopy, at half filling and with small concentrations of extra charge doped into the chains via high oxygen pressure growth. The single- particle gap is reduced with oxygen doping, but the metallic state is not reached. The bandwidth of the charge-transfer band increases with doping, while the state becomes narrower, allowing unambiguous observation of separated spinon and holon branches in the doped system. The optical gap is not changed upon doping, indicating that a shift of chemical potential rather than decrease of corelation gap is responsible for the apparent reduction of the photoemission gap.Comment: 4 pages, 2 figure

Declining Valuations and Equilibrium Bidding Central Bank Refinancing Operations.

It is argued that bidders in liquidity-providing central bank operations should typically possess declining marginal valuations. Based on this hypothesis, we construct equilibrium in central bank refinancing operations organised as variable rate tenders. In the case of the discriminatory pricing rule, bid shading does not disappear in large populations. The predictions of the model are shown to be consistent with the data for the euro area.Open market operations ; Uniform price auction ; Discriminatory auction ; Eurosystem.

Proposal for an Experiment to Test a Theory of High Temperature Superconductors

A theory for the phenomena observed in Copper-Oxide based high temperature superconducting materials derives an elusive time-reversal and rotational symmetry breaking order parameter for the observed pseudogap phase ending at a quantum-critical point near the composition for the highest $T_c$. An experiment is proposed to observe such a symmetry breaking. It is shown that Angle-resolved Photoemission yields a current density which is different for left and right circularly polarized photons. The magnitude of the effect and its momentum dependence is estimated. Barring the presence of domains of the predicted phase an asymmetry of about 0.1 is predicted at low temperatures in moderately underdoped samples.Comment: latex, 2 figure