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Market liquidity and funding liquidity
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In this article, the authors provide a model that links an asset's market liquidity and traders' funding liquidity, i.e., the ease with which they can obtain funding, to explain the empirically documented features that market liquidity can suddenly dry up, has commonality across securities, is related to volatility, is subject to flight to quality, and comoves with the market.Abstract:
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 Riskread more
Citations
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References
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Book ChapterDOI
Market Liquidity: Asset Pricing with Liquidity Risk
TL;DR: In this paper, a simple equilibrium model with liquidity risk is proposed, where a security's required return depends on its expected liquidity as well as on the covariances of its own return and liquidity with the market return.
Journal ArticleDOI
Over-the-counter markets
TL;DR: In this paper, the authors study how intermediation and asset prices in over-the-counter markets are aected by illiquidity associated with search and bargaining, and compute explicitly the prices at which investors trade with each other as well as marketmakers' bid and ask prices in a dynamic model with strategic agents.
Journal ArticleDOI
A Model of Reserves, Bank Runs, and Deposit Insurance
John B. Bryant,John B. Bryant +1 more
TL;DR: In this article, a model is presented in which demand deposits backed by fractional currency reserves and public insurance can be beneficial, and the case for demand deposits, reserves, and deposit insurance rests on costs of illiquidity and incomplete information.
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