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Market liquidity and funding liquidity

Markus Brunnermeier and Lasse Pedersen

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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.

Keywords: liquidity risk management; liquidity; liquidation; systemic risk; Leverage; margins; haircuts; value-at-risk; counterparty credit risk (search for similar items in EconPapers)
JEL-codes: G10 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2007-02-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (76)

Downloads: (external link)
http://eprints.lse.ac.uk/24478/ Open access version. (application/pdf)

Related works:
Journal Article: Market Liquidity and Funding Liquidity (2009) Downloads
Working Paper: Market Liquidity and Funding Liquidity (2007) Downloads
Working Paper: Market Liquidity and Funding Liquidity (2007) Downloads
Working Paper: Market Liquidity and Funding Liquidity (2007) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:24478

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