ABSTRACT
The objective of this paper is to explore how an externality arising from forced asset sales (‘firesale’) affects the choice of banks’ funding structure, and hence the relationship between bank competition and financial stability. It analyses a simple liquidity modelling framework in which funding decisions affect the bank returns in the event of an asset fire-sale. This is especially relevant to understanding the role of systemic liquidity risk in episodes of financial instability, such as in the recent global financial crisis. See inter alia Milne (2009), Brunnermeier (2009), Gorton (2010), Shleifer and Vishny (2011), and Besar et al. (2011).
