Leaning Against the Wind

Abstract

During financial disruptions, market makers provide liquidity by absorbing external selling pressure. They buy when the pressure is large, accumulate inventories, and sell when the pressure alleviates. This paper studies optimal dynamic liquidity provision in a theoretical market setting with large and temporary selling pressure and order-execution delays. I show that competitive market makers offer the socially optimal amount of liquidity, provided they have access to sufficient capital. If raising capital is costly, this suggests a policy role for lenient central bank lending during financial disruptions. Copyright 2007 The Review of Economic Studies Limited.

Presidential Address: Asset Price Dynamics with Slow‐Moving Capital

“…Intermediaries profit by absorbing order imbalances until they can be reduced. Nagel (2009), Lou (2009), and Rinne and Suominen (2010) offer additional evidence on return reversals due to price pressure, as suggested in the theory of Weill (2007).…”

An Empirical Equilibrium Model of a Decentralized Asset Market

“…Spulber (1999) provided a thorough analysis of intermediaries between customers and suppliers. Weill (2007) presented a search-and-bargaining model to understand how intermediaries provide liquidity by accumulating inventories when selling pressure is great, and then dispose of those inventories after that selling pressure has subsided. Recent empirical analyses of nonfinancial intermediaries include Hall and Rust (2000), who focused on the inventory investment of a single steel wholesaler, and Gavazza (2011a), who focused on the role of lessors in reallocating commercial aircraft.…”

Competing for Order Flow in OTC Markets

“…However, in contrast to our model, the brokers in these models do not contribute to the matching of orders on both sides of the market and do not intermediate trades. Weill (, appendix IV) offers some preliminary analysis of a competitive search equilibrium without free entry of dealers. Rocheteau and Weill (, p. 272) apply competitive search to a simple model of an OTC market where trades are not intermediated by dealers and asset holdings are restricted to .…”

“…This is the generalization of the Hosios () condition for efficiency in a two‐sided random search market. Weill () derived a related result in an economy without free entry but in which dealers can hold inventories. The corollary thus establishes that unless the matching function has a constant elasticity (as in the Cobb–Douglas matching function) or the two sides of the market have the same endogenous tightnesses, the Hosios condition will not hold for a single bargaining power of dealers.…”