Strains on Money Market Makers and Money Market Liquidity

We analyze the trading book of a key market maker in the European unsecured money market and study the extent to which liquidity risks accumulated by this market maker affect his pricing of liquidity and the bid/ask spread he quotes on unsecured borrowing and lending. We find that the larger the funding liquidity risk he assumed, the higher is the price he quotes for liquidity. Furthermore, his bid-ask spread increases as his accumulated liquidity risk rises. These findings show that the distribution of liquidity risks within the banking sector matters for the pricing and liquidity in the unsecured money market