Information spillover and liquidity externality across securities is of practical importance to both practitioners and policy makers. We empirically examine how information spillover facilitates liquidity externalities between the equity and corporate bond markets. An event study was conducted by comparing the change of liquidity of stocks whose corporate bonds are TRACE-eligible with that of n...

One of the most important lessons learned from the recent financial crisis is that liquidity risk is fundamentally different from other forms of risk such as market risk and credit risk. Liquidity risk, viewed earlier as a second order risk, is now considered a major risk class. The crisis showed us how quickly a risk which starts as a market or credit risk transforms into a liquidity event and...

We lay out and simulate a multi-agent, multi-period model of an RTGS payment system. At the beginning of the day, banks choose how much costly liquidity to allocate to the settlement process. Then, they use it to execute an exogenous, random streamof payment orders. If a bank’s liquidity stock is depleted, payments are queued until new liquidity arrives from other banks, imposing costs on the d...

This paper adopts the methodology used by Fama and French (1993) to construct two measures of liquidity risk. These liquidity proxies solve the empirical issue of comparability between risk factors by utilizing the standardized unit of risk first proposed for size and value effects. As far as I know, this has not been done before. Modeling these additional liquidity premiums indicate an improve...

The liquidity crisis in 2008 sparked interest in the role of regulation that could promote resilience and stability in the banking system. While the Public Interest theory suggests that legal policies could discipline banking activities, the Private Interest theory predicts otherwise, which impairs banking performance. The conflicting theories warrant comprehensive research, especially for Isla...

This paper develops a search-theoretic model of the cross-sectional distribution of asset returns, abstracting from risk premia and focusing exclusively on liquidity. I derive a float-adjusted return model (FARM), explaining the pricing of liquidity with a simple linear formula: In equilibrium, the liquidity spread of an asset is proportional to the inverse of its free float, the portion of its...

So far the main body of the asset pricing literature has computed liquidity risk premia for either markets or single assets. The vast majority of these studies have been focused on fairly liquid assets, but recently a greater attempt to price such an important component of the asset pricing factors in markets with high illiquidity (especially in real estate) has also started to take place. The ...

This paper presents an analysis of the liquidity effect in the euro area – the link between the availability of aggregate liquidity and the interbank overnight rate. Applying a set of assumptions which also lead to the “martingale property” of the overnight rate, a model linking the latter to the expected aggregate liquidity conditions is formulated and calibrated. Different assumptions for how...

Financial institutions around theworld expected themillennium date change (Y2K) to cause an aggregate liquidity shortage. Responding to the concern, the Federal Reserve Bank of New York auctioned Y2K options to primary dealers. The options gave the dealers the right to borrow from the Fed at a predetermined interest rate. Using the implied volatilities of Y2K options and the on/off-the-run spre...

Many small over-the-counter (OTC) markets with thinly-traded assets are prone to episodic volatility and market failure due to their high potential for predatory activity. The traders in these markets constitute a tight oligopoly and liquidity events become known to all parties quickly. However, these markets appear to function at relatively low spreads and market failure is rare. We show that ...