We provide a model that links an asset's market liquidity - i.e., the ease with which it is traded - and traders' funding liquidity - i.e., the ease with which they can obtain funding. Traders provide market liquidity, and their ability to do so depends on their availability of funding. Conversely, traders' funding, i.e., their capital and the margins they are charged, depend on the assets' market liquidity. We show that, under certain conditions, margins are destabilizing and market liquidity and funding liquidity are mutually reinforcing, leading to liquidity spirals. The model explains the empirically documented features that market liquidity (i) can suddenly dry up, (ii) has commonality across securities, (iii) is related to volatility, (iv) is subject to “flight to quality¶, and (v) comoves with the market, and it provides new testable predictions. Keywords: Liquidity Risk Management, Liquidity, Liquidation, Systemic Risk, Leverage, Margins, Haircuts, Value-at-Risk, Counterparty Credit Risk

Market liquidity and funding liquidity

We provide a model that links a security’s market liquidity — i.e., the ease of trading it — and traders’ funding liquidity — i.e., their availability of funds. Traders provide market liquidity and their ability to do so depends on their funding, that is, their capital and the margins charged by their financiers. In times of crisis, reductions in market liquidity and funding liquidity are mutually reinforcing, leading to a liquidity spiral. The model explains the empirically documented features that market liquidity (i) can suddenly dry up (i.e. is fragile), (ii) has commonality across securities, (iii) is related to volatility, (iv) experiences “flight to liquidity” events, and (v) comoves with the market. Finally, the model shows how the Fed can improve current market liquidity by committing to improve funding in a potential future crisis.

/pdf/market-liquidity-and-funding-liquidity-h8pfs6l9wc.pdf

Market Liquidity and Funding Liquidity

This article investigates the economic effects of conflict, using the terrorist conflict in the Basque Country as a case study. We find that, after the outbreak of terrorism in the late 1960's, per capita GDP in the Basque Country declined about 10 percentage points relative to a synthetic control region without terrorism. In addition, we use the 1998-1999 truce as a natural experiment. We find that stocks of firms with a significant part of their business in the Basque Country showed a positive relative performance when truce became credible, and a negative relative performance at the end of the cease-fire.

https://www.jstor.org/stable/pdfplus/3132164.pdf

The Economic Costs of Conflict: A Case Study of the Basque Country

We present a set of stylized empirical facts emerging from the statistical analysis of price variations in various types of financial markets. We first discuss some general issues common to all statistical studies of financial time series. Various statistical properties of asset returns are then described: distributional properties, tail properties and extreme fluctuations, pathwise regularity, linear and nonlinear dependence of returns in time and across stocks. Our description emphasizes properties common to a wide variety of markets and instruments. We then show how these statistical properties invalidate many of the common statistical approaches used to study financial data sets and examine some of the statistical problems encountered in each case.

/pdf/empirical-properties-of-asset-returns-stylized-facts-and-3gbrgrs0vm.pdf

Empirical properties of asset returns: stylized facts and statistical issues

/pdf/modern-applied-statistics-with-s-fourth-edition-fw5louzblu.pdf

Modern Applied Statistics with S Fourth edition

This book is an ambitious effort by three well-known and
 well-respected scholars to fill an acknowledged void in the
 literature—a text covering the burgeoning field of empirical finance.
 As the authors note in the preface, there are several excellent books
 covering financial theory at a level suitable for a Ph.D. class or as
 a reference for academics and practitioners, but there is little or
 nothing similar that covers econometric methods and applications.
 Perhaps the closest existing text is the recent addition to the Wiley
 Series in Financial and Quantitative Analysis. written by Cuthbertson
 (1996). The major difference between the books is that Cuthbertson
 focuses exclusively on asset pricing in the stock, bond, and foreign
 exchange markets, whereas Campbell, Lo, and MacKinlay (henceforth CLM)
 consider empirical applications throughout the field of finance,
 including corporate finance, derivatives markets, and market
 microstructure. The level of anticipation preceding publication
 can be partly measured by the fact that at least three reviews
 (including this one) have appeared since the book arrived. Moreover,
 in their reviews, both Harvey (1998) and Tiso (1998) comment on the
 need for such a text, a sentiment that has been echoed by numerous
 finance academics.

/pdf/the-econometrics-of-financial-markets-gsz6uyl6wd.pdf

A. Craig MacKinlay

Papers

The econometrics of financial markets