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- Title
Market Liquidity and Funding Liquidity.
- Authors
Brunnermeier, Markus K.; Pedersen, Lasse Heje
- 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.
- Subjects
LIQUIDITY (Economics); CAPITAL requirements; EMPIRICAL research; RISK premiums
- Publication
Review of Financial Studies, 2009, Vol 22, Issue 6, p2201
- ISSN
0893-9454
- Publication type
Article
- DOI
10.1093/rfs/hhn098