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Optimal liquidity reserve with funding liquidity risk

In this article, we take the funding liquidity risk into account when determining the optimal liquidity reserve ratio for a commercial bank. A simple continuous-time model is developed, and a discrete-time model is built as a benchmark. We find that compared with the continuous-time model, the discrete-time model would generate a higher reserve ratio when the illiquid project has low haircut rate, and a lower reserve ratio when the project has high haircut rate.