Market Liquidity and Funding Liquidity

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ID: 289554
2008
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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 margin requirements, depends 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) co-moves with the market. The model provides new testable predictions, including that speculators' capital is a driver of market liquidity and risk premiums.
Reference Key
openalex_W3121630491 Use this key to autocite in the manuscript while using SciMatic Manuscript Manager or Thesis Manager
Authors Markus K. Brunnermeier, Lasse Heje Pedersen
Journal review of financial studies
Year 2008
DOI
10.1093/rfs/hhn098
URL
https://doi.org/10.1093/rfs/hhn098
Keywords Keywords not found

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