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Market liquidity and funding liquidity

Brunnermeier, Markus K. and Pedersen, Lasse Heje (2007) Market liquidity and funding liquidity. Discussion paper, 580. Financial Markets Group, London School of Economics and Political Science, London, UK.

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Identification Number: 580

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.

Item Type: Monograph (Discussion Paper)
Official URL: http://fmg.lse.ac.uk
Additional Information: © 2007 The Authors
Subjects: H Social Sciences > HF Commerce
H Social Sciences > HG Finance
H Social Sciences > HB Economic Theory
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Collections > LSE Financial Markets Group (FMG) Working Papers
Date Deposited: 22 Jul 2009 08:30
Last Modified: 27 Feb 2014 15:35
URI: http://eprints.lse.ac.uk/id/eprint/24478

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