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We model competition for liquidity provision between high-frequency traders (HFTs) and slower execution algorithms (EAs) designed to minimize investors’ transaction costs. Under continuous pricing, EAs dominate liquidity provision by using aggressive limit orders to stimulate HFTs’ market orders. Under discrete pricing, HFTs dominate liquidity provision if the bid-ask spread is binding at one tick. If the tick size (minimum price variation) is not binding, EAs choose between stimulating HFTs and providing liquidity to non-HFTs. Transaction costs increase with the tick size but can be negatively correlated with the bid-ask spread when all traders can provide liquidity. This research is supported by National Science Foundation grant 1,352,936 (jointly with the Office of Financial Research at the US Department of the Treasury) and National Science Foundation grant 1,838,183.

I present a model in which sellers can signal the quality of an asset both by retaining a fraction of the asset and by choosing the liquidity of the market in which they search for buyers. Although these signals may seem interchangeable, I present two settings which show they are not. In the rst setting, sellers have private information regarding only asset quality, and I show that liquidity dominates retention as a signal in equilibrium. In the second setting, both asset quality and seller impatience are privately known, and I show that both retention and liquidity operate simultaneously to fully separate the two dimensions of private information. Contrary to received theory, the fully separating equilibrium of the second setting may contain regions where market liquidity is increasing in asset quality. Finally, I show that if sellers design an assetbacked security before receiving private information regarding its quality, then the optimality of standard debt is robust to the paper’s various settings.

The study examines the bank-specific and external factors that affect the liquidity risk in commercial banks in Bangladesh. The study has been conducted using 23 banks data from 2005-2018, and panel data is used to conduct the regression analysis. Among the bank-specific factors, asset size has a negative relationship with liquidity risk. The larger the bank size, the better the liquidity position and the lower the liquidity risk. Return on equity and capital adequacy ratio has a positive but insignificant relationship with the liquidity risks. In the case of macroeconomic factors, inflation negatively affects the liquidity risks, whereas GDP and domestic credit positively affect. Private and public sector credits increase the investments, which in turn fuel GDP growth. Growth in domestic credit reduces liquidity and may create insolvency. The loan outstanding to asset ratio is positively related to the liquidity risk of the banks. Banks usually increase the loan/advance disbursement to increase profitability, which dries out liquidity and enhances liquidity risk. The study concludes that although several factors are found insignificant yet have positive/negative relation, the banks must carefully evaluate the factors to avoid a future liquidity crisis.

I present a model to study the linkages between the market for liquidity and the international allocation of economic activity. Private assets' liquidity properties affect interest rates, with consequences on entry, production, and market capitalization. In a closed economy, the liquidity market increases the size and productivity of the sector that generates liquid assets. In an open economy, cross‐country differences in financial development generate an allocation of economic activity favoring the country supplying the most liquid assets. Supporting the theory, I show that asset acceptability as collateral is negatively correlated with yields, and positively correlated with measures of economic activity.

This paper examines the effects of bond liquidity on firms’ investments. We postulate that bond liquidity increases firms’ investment opportunities by reducing the cost of capital and improving access to financing. Using the variation in liquidity generated by several positive and negative exogenous shocks, we find that firms respond to positive (negative) shocks by expanding (contracting) capital expenditures and acquisition activity. Further, by enhancing access to funding, bond liquidity facilitates acquisition financing and reduces the likelihood of investment delays. Notably, we find a positive impact of bond liquidity on market valuations and profitability, suggesting that these investments are value-increasing.

The concept of informed trading is closely linked to the activity of speculators. Speculators utilize the information they possess, regarding the prospects of a firm, to profit from undertaking certain trading positions. Essentially, speculators trade because their beliefs about the intrinsic value of the asset differs from the observed market price. By buying underpriced or by selling overpriced securities, they profit from the convergence of a security’s price towards its “fair” value. Speculators can be categorized in styles for formulating their views about a firm’s security price as well as for translating their beliefs into certain trading strategies. On one hand, value traders evaluate all the available information so as to determine the fundamental value of an instrument, hence, assessing whether an instrument’s market price properly reflects its intrinsic value. On the other hand, news traders focus on changes in the fundamental value of an instrument, should any news arise in the market. News traders consider that the current market prices represent all the available information in the market, but the news they observe. In order to be profitable, news traders have to respond much quicker to any public news relative to other traders. Finally, arbitrageurs search for discrepancies in the market prices of similar instruments, usually traded in different markets, which are driven by the same fundamental factors. In a sense, they exploit inefficiencies in the markets that can be attributed to market frictions. In short, informed traders increase market efficiency by moving market prices towards equilibrium values, while uninformed traders (noise traders) trade for reasons that are exogenous to the fundamental value of the asset.In search of the fundamental value of an asset, all trading styles of informed trading are exposed to liquidity risk. Liquidity risk affects the capacity of traders in executing their orders without affecting the quoted prices. In a sense, liquidity risk limits the arbitrage opportunities of informed traders. Liquidity risk can take the form of systematic liquidity that curtails the ability of all market participants to trade, or of idiosyncratic liquidity that affects the price of a particular asset. Systematic liquidity risk can arise from money market contagion or from an increase of counterparty risk. Whereas, idiosyncratic liquidity can stem from adverse selection risk or price uncertainty. So far, we have subtly touched on three distinct components that are expected to be priced in a firm’s credit spreads. The first component regards the fundamental value of the asset, the second considers systematic liquidity conditions while the third pertains to the idiosyncratic liquidity of the asset. As far as the first component is concerned, it focuses on the information contained in a firm’s financial statements . Financial statements constitute the most typical source of information that is periodically available to all investors. Essentially, fundamental value strategies are motivated by the information residing in financial statements. However, while there is an entire industry dedicated to translating the wealth of information that is contained in the published financial reports of a company into some objective indication of its credit standing, the way by which this information is absorbed by the credit markets is still unclear. To state it differently, credit picking, being the essence of value trading, remains a rather opaque process. At the same time, part of the information contained in the forthcoming financial statements, may be translated into fundamental value strategies before the announcement day by informed investors. In a sense, informed trading could facilitate the convergence between the fundamental value of an asset and its market price before the official release of financial statements. The second constituent concentrates on the impact of systematic liquidity on the formation of a firm’s credit risk premium. The price of a security depends on the capacity of arbitrageurs to access the required capital so as to implement their strategies, which would drive market prices towards an equilibrium level. Hence, dislocation in the money or/and capital markets can lead to a severe disruption in the assets market. Indeed, the withdrawal of funding after the Lehman’s collapse forced arbitrageurs to liquidate their positions, causing a steep drop in asset prices. As arbitrageurs ceased to provide liquidity and started to require liquidity from the market, the price of liquidity skyrocketed. Specifically, on 16 September 2008 the price for accessing the unsecured interbank market more than tripled to reach 6.4%. At the same time, repo haircuts for securities other than Treasuries soared from less than 1%, prior to Lehman’s collapse, to 45% (Gorton and Metrick 2011). Elevated information asymmetry during that period hampered investors from identifying the credit risk of each market participant. Hence, they demanded a higher compensation for providing financing across counterparties, or at the extreme of adverse selection fears they became unwilling to lend at all. The substantial rise in the funding cost even for major investment banks curtailed their ability to draw short-term funding, so leading to a substantial increase in their distress risk as reflected in their CDS spreads. Rehypothecation lenders were deterred from rolling over their financing not only to arbitrageurs (hedge funds) but also to investment banks, since their counterparties were more prone to failure and themselves lacked infrastructure to manage the risks arising from holding less liquid securities in their portfolios. Consequently, the capacity of investment banks to fund their own balance sheets as well as their clients was substantially diminished. Essentially, the clients of investment banks were compelled to deleverage in their portfolios, so further plummeting asset prices. In short, systematic liquidity risk enters the credit spread as an exogenous trading cost component that has to be priced. However, to what extent the corporate credit spreads encompass any systematic liquidity premiums arising from the conditions in the local or/and in the global markets, and whether these premiums are affected by changes in the credit standing of a firm’s home country, remain pending issues not investigated until now. Information can be publicly available to everyone or solely held by privately informed investors. Public information is utilized by news traders, while private information is employed by value traders and arbitrageurs in setting up their trading strategies. Value traders are subject to the risk of being adverse selected by the dealer in case he believes that value traders hold valuable private information. That is, in implementing their strategies, value traders have to bear with any idiosyncratic liquidity cost components, which arise from adverse selection and/or asset price uncertainty. These surcharges required by the liquidity provider are endogenous, as they are subject both to the value of the asset and the counterparty participating in the trade. In a sense, dealers’ quote adjustment practices would shape the profits of value traders under the price discovery process, so giving rise to a two-fold question. The first part relates to whether dealers are right in classifying their clients into informed and uninformed, conditional on the excess returns that each investor category subsequently enjoys. A manifestation of the adverse selection cost component can be the premium that dealers surcharge on their informed clients. While the second part questions whether the quoting strategy followed by the dealers proves to be profitable for the dealers themselves. To state it differently, the extent that dealers may manage to front-run informed traders, so that they share part of the value traders’ profits, is something that has not been studied as such yet. The credit risk markets offer us the opportunity to assess the importance of all those components and confirm the mechanism that underlies their formation. For this purpose, we pursue under this study a comprehensive investigation of the informational content and trading cost components of credit spreads. In doing so, we unfold our empirical research into three distinct, yet complementary, parts. That is, each section of the analysis concentrates on a different component of corporate credit spreads. Initially, we distinguish informed trading motivated by the financial statement announcement into different trading styles. To state it differently, we identify what are the useful pieces of information contained in a firm’s financial statements that attract the attention of each trading style. Considering that arbitrage strategies between equity and CDS markets suggest that price discovery in the one market should affect prices in the other and vice versa, we examine the actual importance of the officially published accounting data for the value trader in the credit market. Essentially, the information available to CDS traders act as an upper informativeness bound in the formation of credit spreads, whereas CDS spreads controlled for the information of equity traders provide the respective lower floor. Our results indicate that value traders are the main speculators in the CDS market, since we find fundamental analysis to be relevant for determining CDS spread changes. Whereas, news trading is only relevant for earnings and cash flow protection information around the announcement date window. Overall, financial ratios are statistically significant in the pricing of CDS spreads, even after controlling for the information already present in the equity market or the macroeconomic environment. This finding implies that part of the fundamental value information is discovered through alternative markets. Indeed, it might be that arbitrageurs profit by trading both in the equity and in the CDS markets. Changes in financial ratios are absorbed gradually by the CDS market, with a significant part already captured in a firm’s CDS spread well before the announcement date. This part also reflects information that has already been disseminated in the market prior to the official release of financial statements (e.g. issuance of a new bond that leads to an increase in leverage). Furthermore, the CDS market appears to precede the equity market in assimilating certain financial ratios both before and after the announcement date of financial statements. Hence, it supports the preference of privately informed traders for the CDS market as well as the bridging role of arbitrageurs between the two markets. Our results also verify the asymmetrical impact of financial ratios on the market’s perception of a company’s credit risk, by identifying changes in the magnitude and in the statistical significance among the regressors that drive CDS widening vs. tightening. Finally, our findings suggest that value traders have already priced part of both the imminent negative and positive news related to a firm’s leverage and liquidity before the announcement date. Whereas, most of the good and bad news “surprises” regarding a firm’s profitability are absorbed around the announcement date.For the second part of our empirical research we first establish whether systematic liquidity is priced in the corporate CDS spreads and then examine any differentiation in its impact across countries or/and sectors and ratings events. Our findings indicate an exogenous systematic liquidity cost component in corporate CDS spreads, since dealers that are exposed to funding risk via the money market channel price it into their quoted credit spreads. Regarding the country sensitivity analysis, we find that an increase in systematic liquidity risk in North America, as it is reflected in TED spread, tighten corporate CDS spreads outside North America. In a sense, our findings complement the literature that explores contagion effects among countries by identifying how increased systematic liquidity in the USA is translated into CDS returns for firms located outside the USA.On the other hand, we discover that a rise in the domestic systematic liquidity risk, as captured by the spread over GCRR , widens local firms’ CDS spreads. The sector analysis suggests that claims on financial firms, across all countries examined, are more vulnerable to systematic liquidity risk compared to non-financial firms. To sum up, the systematic liquidity premium is influenced by systematic liquidity risk conditions not only inside a firm’s home country but also outside a firm’s home country as well as by the sector that a firm belongs. Changes in the credit standing of the home country also affected the systematic liquidity cost components in the CDS spreads of its local firms. Our results indicate that when the issuer country was downgraded, an increase in TED spread exacerbated the widening of corporate CDS spreads. In a sense, our findings suggest increased vulnerability of the downgraded country to systematic shocks. Whereas, when a country’s upgrade coincided with a rise in systematic liquidity risk outside the country, home firms’ CDS spreads further tightened. In other words, country credit rating changes amplified the pricing impact of systematic liquidity on the CDS spreads of their local firms.Finally, we find some evidence that the CDS spreads of firms located in vulnerable economies with positive outlook changes, tightened due to “local” while widened due to “global” heightened systematic liquidity risk. That is, the precarious economic conditions in a country rendered its home firms more susceptible to negative global developments. Overall, our analysis suggests that the systematic liquidity cost component that value traders have to pay depends also on the credit standing changes of the country where a firm is located.In the third part of this study we examine whether the dealers’ quote adjustment strategies vary across clients belonging to different investor categories. Our empirical evidence suggests that dealers pre-classify their clients into informed and uninformed based on their identities, giving rise to dealers’ “prejudice” costs. That is, our analysis identifies an extra parameter that dealers consider in their quote setting process, other than the size, the direction and the sequence of the last few orders they fill according to market microstructure theory. In doing so, dealers update accordingly their expectations regarding the price of a security, and in a sense, try to share in the value traders profits. To state it differently, our findings suggests the presence of an endogenous cost component in a firm’s credit spread, as traders are being overcharged by the liquidity provider (dealer). This finding is further substantiated by complementing our empirical conclusions with a theoretical model that explicitly incorporates the investor category in the quote setting process adopted by the dealers as well as with a simulation exercise. The results of the simulation exercise suggest that the P&L generated for a dealer that uses our extended sequential trade model is significantly higher relative to the respective P&L that he would have enjoyed if he had employed the model of Easley O’Hara (1992).Considering that the excess returns enjoyed by each investor category have to be proportional to the level of the private information it possesses, we next find evidence that institutional investors do earn more often than not in the longer horizons, while retail investors do lose more often than not in the longer horizons. Hence, we assert that dealers are right in a-priory classifying institutional investors as value traders and retail investors as noise traders. The aforementioned pre-classification proves also to be much more profitable for the dealers themselves, relative to a “naive” strategy that would uniformly classify all investors as uninformed. Essentially, dealers appear to “front-run” successfully value traders. Last but not least, our results imply that dealers, being the market makers, are most efficient as news-traders. Indeed, they are the ones benefiting more often than not in trades propelled by public information releases. Overall, our analysis suggests that value traders are the main type of speculators in the market, while news traders are the dealers. The findings of this empirical research can be translated into a series of important implications for various stakeholders. These include, among others, the following:1.Comprehensive models, which combine variables both from a firm’s financial statements and from the equity market, are the ones used by speculators.2.Default risk cannot all be inferred from the equity market.3.The identification of the asymmetric impact of factors that drive the narrowing vs. the widening of CDS spreads can help us make out the utility function of risk-averse participants. At the same time, it can facilitate market participants to better manage the risk of their positions as well as properly formulate their investments strategies.4.Systematic liquidity cannot be ignored in the pricing of credit risk, as it gives rise to significant cost components in corporate CDS spreads.5.The appropriateness of measures taken by the central banks in the USA and in Europe in supporting the financial system during the latest financial crisis is confirmed. 6.Models analysing adverse selection risk or the quote-adjustment mechanism should take into account some sort of counterparty “prejudice” from the point of view of the dealer.

Using a structural model, we estimate the liquidity multiplier of an interbank network and banks’ contributions to systemic risk. To provide payment services, banks hold reserves. Their equilibrium holdings can be strategic complements or substitutes. The former arises when payment velocity and multiplier are high. The latter prevails when the opportunity cost of liquidity is large, incentivising banks to borrow neighbors’ reserves instead of holding their own. Consequently, the network can amplify or dampen shocks to individual banks. Empirically, network topology explains cross-sectional heterogeneity in banks’ systemic-risk contributions while changes in the equilibrium type drive time-series variation.

We use regression analysis to quantify the impact of investors’ risk perceptions, as measured by VIX, on stock market liquidity in 57 countries. We show that increased risk perception reduces liquidity around the world, and its impact is not subsumed by other well-documented market-level determinants of liquidity. The effect is pervasive, but is stronger in countries with higher GDP per capita, more trade openness, stronger governance, a more individualistic culture, and no short-selling constraints. It is not driven by periods of extreme changes in risk perception, expansionary or recessionary phases of the business cycle, or the way liquidity is measured.

If price volatility is caused in some part by taste shocks, then it should be positively correlated with the liquidity premium. Our argument is based on Krishna and Sadowski (2014), who provide foundations for a representation of dynamic choice with taste shocks, and show that volatility in tastes corresponds to a desire to maintain flexibility. To formally connect volatile tastes to price volatility and preference for flexibility to the liquidity premium, we analyze a modified simple Lucas tree economy with two otherwise identical assets, where one provides more liquidity because its output can be traded on an auxiliary international market, and where the representative agent is uncertain about his degree of future risk aversion. We show that a representative agent with a higher degree of uncertainty about his future risk aversion implies a higher liquidity premium (ie, a higher price for the more liquid asset) and more price volatility.

This paper investigates from a theoretical and empirical perspective the effects of capital controls on cost-based measures of foreign exchange (FX) market liquidity. First, we propose a market microstructure model of the exchange rate where capital controls reduce the trades of constrained dealers. The effect is a tightening of the effective spread, which increases market liquidity. Then, we propose a new measure of capital account restrictiveness that, in contrast to other traditional measures, can account for intensive changes in capital controls policies. Using this measure in a panel of emerging market economies, we provide empirical evidence showing that capital controls can reduce the implicit cost component of FX market liquidity.

This paper studies the welfare properties of mutual funds in a Diamond–Dybvig economy with two sources of aggregate risk: (i) shocks to long-term investment returns; and (ii) shocks to aggregate liquidity demand. Mutual funds are inefficient when the long-term investment is risky. Mutual funds improve upon autarky by introducing a wedge between the market and technological rates of return. However, the wedge distorts the decisions of consumers not facing liquidity shocks, and the resulting equilibrium is inefficient. If only aggregate liquidity demand is subject to shocks, mutual funds can implement the social optimum (even when liquidity demand is not directly observable) by means of a price-contingent dividend policy.

This paper analyzes the effects of financial integration on the stability of the banking system. Financial integration allows banks in different regions to smooth local liquidity shocks by borrowing and lending on a world interbank market. We show under which conditions financial integration induces banks to reduce their liquidity holdings and to shift their portfolios toward more profitable but less liquid investments. Integration helps reallocate liquidity when different banks are hit by uncorrelated shocks. However, when a correlated (systemic) shock hits, the total liquid resources in the banking system are lower than in autarky. Therefore, financial integration leads to more stable interbank interest rates in normal times but to larger interest rate spikes in crises. These results hold in a setup in which financial integration is welfare improving from an ex ante point of view. We also look at the model’s implications for financial regulation and show that, in a second-best world, financial integration can increase the welfare benefits of liquidity requirements. The online appendix is available at https://doi.org/10.1287/mnsc.2017.2841 . This paper was accepted by Neng Wang, finance.

Purpose The purpose of this paper is to investigate the interrelationship between liquidity creation (LC) and bank capital in Vietnamese banking between 2007 and 2015. Design/methodology/approach A three-step procedure is used to measure LC. Thereafter, a simultaneous equations model with a three-stage least squares estimator is employed to examine the links between LC and bank capital. Findings The findings show that large banks mainly contributed a strong growth in LC in Vietnam between 2007 and 2015. The findings also indicate that off-balance sheet activities only played a small role in LC. In addition, the findings indicate a negative two-way relationship between LC and bank capital in Vietnam. The results of the robust checks reinforce the main findings. Practical implications The evidence shows that the implementation of Basel III may reduce LC and greater LC may increase banks’ insolvency. Consequently, this trade-off between the benefits of financial stability induced by tightening capital requirements and those of enhanced LC has important implications for Vietnamese authorities in strengthening the banking system. Originality/value This study is the first attempt to investigate the interrelationship between LC and bank capital in Vietnam, in which fat liquidity creation and non-fat liquidity creation are used and alternative measures of LC are also employed to provide robustness to the main findings.

The US subprime mortgage crisis erupted in 2007, and the most fundamental reason was the depletion of financial intermediation liquidity. The rapid spread of liquidity crisis in the interconnected financial markets, so financial institutions took excessive risks and collapsed. Then the final liquidity risk evolved into systemic risk. Firstly, this paper studies the development history and the latest progress of systematic risk management, the theory of liquidity risk management and the theory of risk-taking behavior management. The paper constructed two dynamic Division number regression to measures ΔCoVaR of 16 commercial banks. Then the dynamic panel regression model is built, which takes the liquidity risk index of individual commercial bank and the interaction between individual commercial bank liquidity risk index and risk-taking index as the main explanatory variables to analyze the banking systemic risk. The research finds that the greater the liquidity risk of individual commercial banks, the higher the contribution of their systemic risk. The risk-taking of individual commercial bank can play an effective role in regulating and weakening its ΔCoVaR. In addition, the large size of the bank does not mean that the greater the contribution of its systemic risk. In terms of liquidity risk regulation, banks would better use liquidity creation indicators and liquidity ratios, rather than loan-to-deposit ratios. Finally, combined with the results of empirical analysis and theoretical analysis, this paper puts forward some suggestions on bank risk management.

The paper develops an early warning system to identify banks that could face liquidity crises. To obtain a robust system for measuring banks’ liquidity vulnerabilities, we compare the predictive performance of three models – logistic LASSO, random forest and Extreme Gradient Boosting – and of their combination. Using a comprehensive dataset of liquidity crisis events between December 2014 and January 2020, our early warning models’ signals are calibrated according to the policymaker's preferences between type I and II errors. Unlike most of the literature, which focuses on default risk and typically proposes a forecast horizon ranging from 4 to 6 quarters, we analyse liquidity risk and we consider a 3-month forecast horizon. The key finding is that combining different estimation procedures improves model performance and yields accurate out-of-sample predictions. The results show that the combined models achieve an extremely low percentage of false negatives, lower than the values usually reported in the literature, while at the same time limiting the number of false positives.

One of the most important developments which adversely affect economies in the globalized world is the financial crises, such as money crisis, banking crises, external debt crises, and systemic financial crises, arising due to various reasons. The reasons of crises can be also listed as unsustainable macroeconomic structure, asymmetric information, moral hazard, financial liberalization, herd psychology, and pandemics. The financial crises emerging in the period in which financial integration formed after 1990, turned into a structure engulfing all economies in waves by coming to a state of structure whose violence and impact area expand rapidly. The 2008 crisis, an important example of financial crisis, which started in mortgage industry in the USA and spread rapidly to the global economy. Also, unlike the previously known classical banking crises, the inclusion of large-volume derivative products in this crisis and the problems related to derivative products spread very rapidly to other parts of the world during the 2008 Global Crisis. The credit rating agencies received criticism in the 2008 Crisis as received in the 1997 Asian Crisis. In particular, the financing of these institutions by banks and other financial institutions reduces the possibility of objective evaluation. They did not take into account the market risk and liquidity risk for the investors trading in the secondary market during the rating process. In addition, the rapid increase in notes and the high amount of payments to be made within the scope of CDO increased the liquidity crisis. As a result, financial liberalization, macroeconomic instability, and weak financial structure under the globalized world make the economies more vulnerable, sensitive and/or insecure to financial crises.

In this paper we analyze the implications of a persistent liquidity trap in a monetary model with asset scarcity and price flexibility. We show that a liquidity trap leads to an increase in cash holdings and may be associated with a long-term output decline. This long-term impact is a supply-side effect that may arise when agents are heterogeneous. It occurs in particular with a persistent deleveraging shock, leading investors to hold cash yielding a low return. Policy implications differ from shorter-run analyses. Quantitative easing leads to a deeper liquidity trap. Exiting the trap by increasing expected inflation or applying negative interest rates does not solve the asset scarcity problem.

This paper studies liquidity risk at the six largest U.S. banks. The starting point is the stress tests performed under the Liquidity Coverage Ratio (LCR) regulation, which compare a bank’s liquid assets to its loss of cash in a stress scenario that regulators say is based on the 2008 financial crisis. These tests find that all of the large banks could endure a liquidity crisis for 30 days without running out of cash. This paper argues, however, that some of the assumptions in the LCR stress scenario are not pessimistic enough to capture what could happen in a crisis like 2008. The paper then proposes changes in the dubious assumptions and performs revised stress tests. For 2019 Q4, the revised tests suggest it is unlikely that any of the six banks would survive a liquidity crisis for 30 days. This negative finding is most clear-cut for Goldman Sachs and Morgan Stanley. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

This paper studies the impact of expected issuance fees on market liquidity in the Euro-area government bond market. We pose that investment banks have a dual role as primary dealer in the secondary market as well as competitor for lead manager in the primary market. Therefore, primary dealers have the incentive to increase liquidity due to competition for issuance fees. We find that the expected issuance fee is significantly related to market liquidity. Issuance fee driven liquidity is especially strong for countries with high funding needs, in periods of high uncertainty, and for bonds with low risk.

We construct a novel panel dataset to provide new evidence on how the largest nonfinancial firms manage the composition of their financial assets. Over the past decade, bond portfolios have grown to be at least as large as cash-like instruments, driven by the meteoric rise of corporate bond holdings. To shed light on the drivers of this growth, we conduct two event studies around the 2017 tax reform and the 2020 liquidity crisis. Our evidence suggests large firms often actively manage their financial portfolios in a way that reflects tax incentives and reach for yield as opposed to financial constraints.

This paper investigates whether FS affects bank liquidity risk. Using the Malaysian banking data sets, we compare the FS-liquidity risk relationships between the Islamic and conventional banking institutions. FSs are measured by real estate financing, financing concentration, short-term FS stability, and finally medium-term FS stability. Meanwhile, for liquidity risk measures, we adopt the BASEL III approach such as liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) in quantifying short- and long-term liquidity risk, respectively. The unbalanced static panel regressions of 27 conventional and 17 Islamic banks from 1994 to 2014 were analyzed to evaluate the relationships. Our results illustrate that increasing number of real estate financing and short-term FS stability of the Islamic banks may increase both their short- and long-term liquidity risks. On the other hand, even though real estate financing does not affect liquidity risks of the conventional banks, increasing short-term FS stability and financing specialization may increase their long-term liquidity risk. As the liquidity risk behavior, to some extent, differs between the two banking systems, we recommend the regulatory bodies and market players to develop a separate liquidity risk management framework for conventional and Islamic banking institutions.

Wide and volatile interest rate spreads in the 2007-2009 financial crisis could represent concerns over asset liquidity or issuer solvency. To precisely identify the contribution of these two effects on sovereign bond and interbank spreads, I propose a model-free measure of euro-area market liquidity, and a measure of near-term interbank default risk. I find that credit and liquidity are independently important. In interbank risk spreads, the role of liquidity dominates, while the importance in sovereign bond yield spreads varies substantially by country and maturity. To better understand the liquidity channel that is captured by the new liquidity measure, but is understated by extant measures, I test the pricing of liquidity risk; the possibility that liquidity could be negatively correlated with marginal utility. I exploit the variation in returns over countries, maturities and time, and find that liquidity euro-area sovereign bond risk premia are large and significant.

The aim of this paper is to investigate the determinants and the joint relationship between capital, risk and liquidity of conventional and Islamic banks. Particularly, we focus on the impact of financial and political instabilities on the risk-taking behavior of conventional and Islamic banks. Using the simultaneous equation model with partial adjustment, we find a positive bidirectional relationship between capital and risk of Islamic banks. Moreover, results highlight the risky aspect of this category of banks mainly caused by the type of contracts put in practice, obeying Sharia principles, such as Moudharaba and Moucharaka contracts. Also, changes in liquidity affect positively risk within Islamic and conventional banks, suggesting that both types of banks, by accumulating liquid assets; tend to have relatively riskier portfolios. Moreover, we find a significant impact of the Global financial crisis on the capital, risk and liquidity of conventional and Islamic banks.

This article examines whether liquidity or credit quality (probability of default) “contributes” more to the explanation of currency excess returns, using two baskets of bilateral exchange ...

This study examines the impact of local and foreign investor sentiment on emerging stock market liquidity. We find a positive (negative) effect of investor sentiment on liquidity (illiquidity). Results also reveal that foreign investor sentiment significantly influences emerging stock market liquidity.

Research on electricity futures markets has to date not explored the role that market liquidity may play in determining risk premia. Further, no detailed empirical examination of both liquidity and risk premia in the New Zealand electricity futures market are discernible. Using data from October 2009 to December 2015, we address these gaps in the literature. We find that liquidity has been gradually increasing and that a policy intervention to impose a maximum bid-offer spread was associated with liquidity-enhancing structural breaks, but this was evident only in the nearest-to-maturity futures contracts. Further, we develop models to explain risk premia that include a range of risk factors, which we categorise as either statistical, physical market, production cost or liquidity variables. From this analysis, we document significant time-varying premia that are driven by potentially inefficient behaviour. Finally, we find that liquidity risk does affect risk premia, but generally only in the case of longer-dated futures.

An extensive review of the evidence related to the 2007–09 crisis reveals that it was an insolvency risk crisis, not a liquidity crisis. The appropriate post-crisis regulatory reform should therefore focus on increasing capital requirements. The Basel III liquidity requirements do not serve a useful economic purpose in dealing with the root causes of the stresses that led to the 2007–09 crisis, and unnecessarily constrain the asset transformation and liquidity creation roles of banks to the detriment of economic growth.

We combine the market with earnings, liquidity and their respective growth, with motivation via a simple pricing equation, to model the cross-section with three, four and five factors. As first-order variables in widespread investor use for over a hundred years, earnings and liquidity have ready connection to investor preferences. They obtain as good a cross-sectional description of security prices as other factor models without redundancy. We weight portfolios on volume, relying on a direct SDF representation of investor’s preference for liquidity, demonstrating its additional dimension. Recent research arguing for the demise of liquidity is premature; indeed, its importance has grown.

This article investigates the relationship between credit and liquidity risk components in the UK interbank spread during the recent financial crisis and sheds light on the transmission mechanism of the quantitative easing (QE) carried out by the Bank of England (BoE) on short-term interest rates. Specifically, we find that prior to the bank’s intervention counterparty risk was a major factor in the widening of the spread and also caused a rise in liquidity risk. However, this relationship was reversed during the period when QE was implemented. Using the accumulated value of asset purchases as a proxy for the central bank’s liquidity provisions, we provide evidence that the QE operations were successful in reducing liquidity premia and ultimately, and indirectly, credit risk. We also find evidence that suggests liquidity schemes provided by other central banks and international market sentiment contributed to the reduction of interbank spread.

We examine effective measures of liquidity in the context of EU sovereign bonds and the Basel III regulatory framework. We observe that the empirical correlations between benchmarks and proxies are typically very low and in general become weaker as the frequency over which these relationships are examined becomes higher, and that the relative strength of the various proxies may change with the frequency considered. The main implications of our results for the EU sovereign bond market are (i) the use of liquidity proxies may lead to erroneous conclusions; (ii) any liquidity measure needs to be assessed against the relevant timeframe for conversion into cash; and (iii) the end-of-day spread is the best performing proxy across different frequencies.

In this paper, we examine the effects of asset liquidity on innovation investments. We show that firms with highly liquid assets tend to invest more in research and development (R&D) and to generate higher numbers of patents and patent citations. These findings hold even after controlling for cash holdings, stock liquidity, and firm characteristics. We hypothesize that the positive effect of asset liquidity on innovation is because this liquidity can help firms reduce the cost of capital. Consistent with this hypothesis, we find that the effect is more pronounced for firms with high cash-flow uncertainty or less capacity to access external equity capital. Overall, our findings show that asset liquidity is an important determinant of innovation.

This paper investigates the cyclicality of bank liquidity creation. Since liquidity creation is a major economic function of banks, their liquidity creation behavior may amplify business cycle fluctuations. Using the methodology of Berger and Bouwman (2009) to compute liquidity creation measures, we analyze the relation between GDP growth and liquidity creation of Russian banks from 2004 to 2015. Detailed quarterly data on a very large sample of banks and coexistence of different bank ownership types (state-owned, domestic private and foreign banks), makes Russia an ideal natural laboratory for study of cyclicality of liquidity creation for banks. We find that liquidity creation of banks is procyclical. We show that the liquidity creation behavior of state-owned banks and foreign-owned banks is similar to that of domestic private banks in terms of procyclicality. We further find that the magnitude of procyclicality is higher for liquidity creation than for lending. Thus, while ownership of banks does not influence the cyclicality of bank liquidity creation, liquidity creation behavior of banks can amplify business cycle fluctuations.

The goal of this study is to explore the effect of financial openness in emerging markets on the domestic financial market liquidity and then to clarify the linkage between financial openness and market liquidity. The empirical results show that higher the degree of the financial market openness enhances the domestic financial market liquidity, and the effect of the financial market openness on the emerging markets is more significance than the developed markets. We expect the empirical results of this study can provide a new insight into the development of emerging financial markets.

The paper seeks to determine whether short selling increases or decreases liquidity in U.S. equity markets. On one hand, prior research indicates that short sellers may act, at times, as liquidity providers. On the other hand, other research in market microstructure argues that spreads will widen in the presence of informed traders – a classification generally given to short sellers. Results from a series of new, multivariate time-series tests show that exogenous shocks to short selling activity generally lead to a widening of bid-ask spreads in smaller-cap stocks. The results, however, do not hold for larger-cap stocks.

This study examines whether and how Equator Principles (EP) adoption has bearings on the liquidity of banks that engaged in project finance from 2003 to 2010. Results reveal that EP Financial Institutions (EPFIs) generally have higher liquidity than non-EPFIs and such a finding remains valid after controlling other variables. Moreover, bank regulations positively affect bank liquidity and such a positive effect is stronger for EP Financial Institutions (EPFIs) than for non-EPFIs. Results suggest that EPFIs hold more liquidity buffers likely because of the higher risks and costs that accompany the adoption of EP as well as more effective bank regulations for EPFIs as opposed to non-EPFIs. In addition, banks that plan to adopt EP in the future should increase their liquidity holdings after adopting EP. Furthermore, authorities concerned should encourage non-EPFIs to adopt EP or other eco-friendly measures so that bank regulations can increase liquidity more effectively.

This paper investigates liquidity spillovers between the US and European interbank markets during turbulent and tranquil periods. We show that an endogenous model with time-varying transition probabilities is effective in describing the propagation of liquidity shocks within the interbank market, while predicting liquidity crashes characterised by changed dynamics. We show that liquidity shocks, originating from movements of the spread between the Asset Backed Commercial Paper and T-bill, drive regime changes in the euro fixed-float OIS swap rate. Our results support the idea of endogenous contagion from the US money market to the eurozone money market during the global financial crisis.

Credit market freezes in which debt issuance declines dramatically and market liquidity evaporates are typically observed during financial crises. In the financial crisis of 2008–2009, the structur...

Dramatic microstructure changes in equity markets have made standard liquidity measures less accurate proxies for trading costs. We develop trade-time liquidity measures that reflect per-dollar price impacts of fixed-dollar volumes. Our measures better capture institutional trading costs and better explain the cross-section of returns than do standard measures, especially in recent years. Despite improvements in measures of market quality, expected trading costs have explanatory power for the cross-section of expected returns: we obtain monthly liquidity premium estimates of 5.3 bp for expected returns and 2.4 bp for risk-adjusted returns. Estimated premiums rise after the financial crisis and remain high thereafter.

In this paper, we derive higher-moment liquidity risks theoretically and examine whether they are empirically priced. We discover that when investors add trading cost to the utility function, the expected return of a stock should contain premia related to three higher-moment liquidity risks. We show that one of our higher-moment liquidity risks, or liquidity coskewness risk, measures an individual stock's marginal contribution to the skewness of portfolio liquidity and is consistently priced. In addition, our analysis of the Hansen-Jagannathan distance and the maximum Sharpe ratio show that the liquidity coskewness risk plays a substantial role in asset pricing and portfolio management.

A neo classical model is proposed to highlight the firm’s endogenous allocation decision over the liquid asset versus capital asset to the extent of firm size and liquidity shortage. Liquidity shock has a long lasting vestige on the firm’s cash holding policy in the aftermath of Great recession. We conduct difference in difference regression to test the effect of firm size and the severity of economic crisis on the cash hoarding. Encompassing 85,559 firm-years from the eight countries spanning from 2002 to 2015, we find precautionary demand prevails among the small firms while transaction cost concern matters for large firms a posteriori 2008 as postulated in the proposed model. As the declining capital asset return entails liquidity hoarding, unilateral governmental sanction against the cash-hoarding may exacerbate investment among the small firms.

The equity market is more liquid under Democratic than Republican presidencies. This is apparent at the market level but is stronger in small, value stocks and in industries that are more sensitive to Democratic presidents. The effect is robust to different liquidity measures and time periods and is not solely driven by variation in the business cycle or macroeconomic variables. A number of factors that influence liquidity, including information asymmetry, volatility, and economic policy uncertainty, are all lower during Democratic presidencies. We also show that liquidity increases in the months following a Democratic president replacing a Republican president.

Using a large and inclusive sample, we assess the market’s perception of the Volcker Rule and its effectiveness. We use both the equity and credit default swap (CDS) market responses to the announcement. Our results suggest that the capital markets perceive the Volcker Rule as a positive regulatory measure overall. Using our own proxy, we examine market reactions to banks targeted and not targeted by the Volcker Rule and find that the overall positive market response to the Volcker Rule appears to be driven by the larger number of non-targeted, smaller banks. We conclude that the Volcker Rule has a positive effect on smaller banks in that it levels the playing field between large and small banks. Further analyses indicate that banks with higher systemic risk, less liquidity, and worse financial reporting quality are more likely to be negatively impacted by the Volcker Rule. The analyses of these characteristics before and after the announcement of the rule also indicate a positive impact of the Volcker Rule.

We examine the relationship between stock liquidity and the difference in domestic and foreign market prices for a sample of 650 international firms cross-listed on a U.S. stock exchange through either an American Depository Receipt (ADR) or an ordinary shares program. We exploit the 2001 change to decimalization pricing and the 2003 U.S. dividend tax cut as quasi-natural experiments and find that ADR liquidity decreases the absolute value of the ADR premium. We document a positive relationship between liquidity and price discovery as well as a liquidity effect on the price convergence between the ADRs and their underlying shares. The effect of liquidity on convergence is stronger for stocks with high holding costs and low institutional ownership.

We disentangle bid- and ask-side liquidity using 11 years of comprehensive NYSE limit order book data and document that this has important implications for understanding the determinants, commonalities and pricing of liquidity. First, the ask- but not bid-side liquidity of financial stocks deteriorates during the 2008 short selling ban. Second, bid-side (ask-side) liquidity decreases (increases) in lagged short- and long-term returns, indicating persistent contrarian behavior in limit orders. Third, liquidity commonality increases during the financial crisis, more so on the bid than on the ask side. Finally, ask- but not bid-side illiquidity predicts daily returns, while both forecast monthly returns.

This study analyzes the impact of economic, financial, and political instability on the liquidity transformation of banks operating in unstable environments. Our main goal is to assess the relation...

To “ensure depth and liquidity,” the European Central Bank intervened in sovereign debt markets through its Securities Markets Programme (SMP), providing a unique opportunity to estimate the effects of large-scale asset purchases on sovereign bond liquidity premia. From reduced-form estimates, we find robust, economically significant impact and lasting reductions in sovereign bonds’ liquidity premia in response to official purchases. We develop a search-based asset-pricing model to understand our empirical results. The theory implies that bond liquidity premia fall in response to both official purchases and rising sovereign default probabilities, as seen in the data.

Purpose The purpose of this paper is to examine the effects of funding liquidity risk and liquidity risk on the bank risk-taking. Design/methodology/approach This study employs a system generalized method of moments (GMM) estimation technique and a sample of 57 banks operating in BRICS countries over the period from 2006 to 2015. Findings The results reveal that liquidity risk has a significant and negative effect on the bank risk-taking, indicating that a decrease in liquidity risk contributes to higher bank risk-taking. The study also reveals that funding liquidity risk has the substantial impact on bank risk-taking, suggesting lower funding liquidity risk results in higher bank risk-taking. These results are consistent with prior assumptions. Research limitations/implications The implications of this study highlight the fact that liquidity risk is a risk factor which drives the potential bank default, of which banks tend to take more risks when higher funding liquidity exists. Practical implications This study offers a number of valuable implications for the policy makers as well as practitioners. The policy makers should take into account better liquidity risk management framework aimed at preventing banks from taking excessive risks. Bank executives must pay more attention on how banks could hold more liquid securities and cash. Less risk-taking reduces higher borrowing costs undermining earnings through imposing taxes on corporate. Originality/value This work uncovered that liquidity risk per se is an important and previously unidentified risk factor, specifically its effects on bank risk-taking and contributes to the view in support of holding more liquid securities than the past.

We show that highly liquid Exchange†Traded Funds (ETFs), especially those that are more liquid than their underlying basket of securities (i.e., positive relative liquidity), are particularly attractive to investors. Using three definitions of liquidity, we find that relative liquidity predicts net fund flows, as well as inflows and outflows positively and significantly. We further document a liquidity clientele among institutional investors: (i) relative liquidity is significantly more important for short†than for long†term investors; and (ii) relative liquidity is inversely related to investors’ average holding duration in the ETFs. These two findings provide evidence that relative liquidity encourages short†term demand.

The models used to calculate post-crisis valuation adjustments, market risk and capital measures for derivatives are subject to liquidity risk due to severe lack of available information to obtain market implied model parameters. The European Banking Authority has proposed an intersection methodology to calculate a proxy CDS or Bond spread. Due to practical issues of this method, Chourdakis et al. introduce a cross-section approach. In this paper, we extend the cross-section methodology using equity returns, and show that our methodology is significantly more accurate compared to both existing methodologies, and produces more reliable, stable and robust market risk and capital measures, and credit valuation adjustment.