The transmission of liquidity shocks via China's segmented money market: evidence from recent market events

Abstract

This is the first study to explore the transmission paths for liquidity shocks in China's segmented money market. We examine how money market transactions create such pathways between China's closely-guarded banking sector and the rest of its financial system, and empirically capture the transmission of liquidity shocks through these pathways during two recent market events. We find strong indications that money market transactions allow liquidity shocks to circumvent certain regulatory restrictions and financial market segmentation in China. Our findings suggest that a widespread illiquidity contagion facilitated by money market transactions can happen in China and new policy measures are needed to prevent such contagion.