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RFS Advance Access published online on August 18, 2004
Review of Financial Studies, doi:10.1093/rfs/hhi001
Review of Financial Studies © The Society for Financial Studies 2004; all rights reserved
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Original Articles

Interbank Market Integration under Asymmetric Information*

Xavier Freixas 1 Cornelia Holthausen 2*
1 Universitat Pompeu Fabra, Ramon Trias Fargas 25-27, E-08005 Barcelona
2 European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany

* To whom correspondence should be addressed. E-mail: cornelia.holthausen{at}ecb.int.


  Abstract

Cross-country bank lending appears to be subject to market imperfections leading to persistent interest rate differentials. In a model where banks need to cope with liquidity shocks by borrowing or by liquidating assets, we study the scope for international interbank market integration with unsecured lending when cross-country information is noisy. We find that an equilibrium with integrated markets need not always exist, and that it may coexist with one characterized by segmentation. A repo market reduces interest rate spreads and improves upon the segmentation equilibrium. However, it may destroy the unsecured integrated equilibrium.

* We thank Mathias Dewatripont, Kose John, Jan Lemmen, Janet Mitchell, Bruno Parigi as well as two anonymous referees. We are also grateful for comments from seminar participants at Birbeck College, ECARE, European Central Bank, Université Paris I, New York University, The Federal Reserve Bank of New York, Stockholm School of Economics, and at the CEPR Euroconference in Tenerife. Financial support from DGICYT grant no. PB93-0388 is gratefully acknowledged.


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