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We study liquidity conditions in the corporate bond market during the COVID-19 pandemic. We document that the cost of trading immediately via risky-principal trades dramatically increased at the height of the sell-off, forcing customers to shift toward slower agency trades. Exploiting eligibility requirements, we show that the Federal Reserve's corporate credit facilities have had a positive effect on market liquidity. A structural estimation reveals that customers' willingness to pay for immediacy increased by about 200 bps per dollar of transaction, but quickly subsided after the Fed announced its interventions. Dealers' marginal cost also increased substantially but did not fully subside. [ABSTRACT FROM AUTHOR]

We propose a model in which assets with identical cash flows can trade at different prices. Infinitely lived agents can establish long positions in a search spot market, or short positions by first borrowing an asset in a search repo market. We show that short-sellers can endogenously concentrate in one asset because of search externalities and the constraint that they must deliver the asset they borrowed. That asset enjoys greater liquidity, a higher lending fee (“specialness”), and trades at a premium consistent with no-arbitrage. We derive closed-form solutions for small frictions, and provide a calibration generating realistic on-the-run premia. [ABSTRACT FROM AUTHOR]

Information collection and processing in financial institutions is challenging. This can delay the observation by traders of the exact capital charges and constraints of their institution. During this delay, traders face preference uncertainty. In this context, we study optimal trading strategies and equilibrium prices in a continuous centralized market. We focus on liquidity shocks, during which preference uncertainty is likely to matter most. Preference uncertainty generates allocative inefficiency, but need not reduce prices. Progressively learning about preferences generate round–trip trades, which increase volume relative to the frictionless market. In a cross section of liquidity shocks, the initial price drop is positively correlated with total trading volume. Across traders, the number of round–trips is negatively correlated with trading profits and average inventory. [ABSTRACT FROM PUBLISHER]

We study an over-the-counter OTC market in which the usefulness of assets as a means of payment or collateral is limited by the threat of fraudulent practices. Agents can produce fraudulent assets at a positive cost, which generates upper bounds on the quantity of each asset that can be traded in the OTC market. Each of these endogenous, asset-specific, resalability constraints depends on the cost of fraud, on the frequency of trade, and on the asset price. In equilibrium, assets are partitioned into three liquidity tiers, which differ in their resalability, prices, haircuts, sensitivity to shocks, and responses to policies. [ABSTRACT FROM AUTHOR]

On November 14-15, 2008, the Federal Reserve Bank of Cleveland hosted a conference on 'Liquidity in frictional asset markets.' In this paper, we review the literature on asset markets with trading frictions in both finance and monetary theory using a simple search-theoretic model, and we discuss the papers presented at the conference in the context of this literature. We will show the diversity of topics covered in this literature, for example, the dynamics of housing and credit markets, the functioning of payment systems, optimal monetary policy and the cost of inflation, the role of banks, the effect of informational frictions on asset trading. [ABSTRACT FROM AUTHOR]

We study a competitive dynamic financial market subject to a transient selling pressure when market makers face a capacity constraint on their number of trades per unit of time with outside investors. We show that profit-maximizing market makers provide liquidity in order to manage their trading capacity constraint optimally over time: they use slack trading capacity early to accumulate assets when the selling pressure is strong in order to relax their trading capacity constraint and sell to buyers more quickly when the selling pressure subsides. When the trading capacity constraint binds, the bid–ask spread is strictly positive, widening and narrowing as market makers build up and unwind their inventories. Because the equilibrium asset allocation is constrained Pareto-optimal, the time variations in bid–ask spread are not a symptom of inefficient liquidity provision. [ABSTRACT FROM AUTHOR]

During financial disruptions, market makers provide liquidity by absorbing external selling pressure. They buy when the pressure is large, accumulate inventories, and sell when the pressure alleviates. This paper studies optimal dynamic liquidity provision in a theoretical market setting with large and temporary selling pressure and order-execution delays. I show that competitive market makers offer the socially optimal amount of liquidity, provided they have access to sufficient capital. If raising capital is costly, this suggests a policy role for lenient central bank lending during financial disruptions. [ABSTRACT FROM AUTHOR]