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Market Liquidity and Funding Liquidity

Author: Markus K Brunnermeier; Lasse Heje Pedersen
Publisher: Cambridge, Mass. National Bureau of Economic Research 2007.
Series: Working paper series (National Bureau of Economic Research), no. w12939.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
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  Read more...
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Details

Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Markus K Brunnermeier; Lasse Heje Pedersen
OCLC Number: 1027321441
Notes: February 2007.
Description: 1 online resource.
Details: Mode of access: World Wide Web.
Series Title: Working paper series (National Bureau of Economic Research), no. w12939.
Responsibility: Markus K. Brunnermeier, Lasse Heje Pedersen.

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.

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