#08-33
The Role of Liquidity in Financial Crises
Franklin Allen and Elena Carletti, September 2008
Abstract: The purpose of this paper is to use insights from the academic literature on crises to
understand the role of liquidity in the current crisis. We focus on four of the crucial features
of the crisis that we argue are related to liquidity provision. The first is the fall of the prices
of AAA-rated tranches of securitized products below fundamental values. The second is the
effect of the crisis on the interbank markets for term funding and on collateralized money
markets. The third is fear of contagion should a major institution fail. Finally, we consider
the effects on the real economy.
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