Liquidity Discovery and Asset Pricing
AbstractAsset prices are risky, in part, because of uncertainty about the preferences of potential counterparties and the terms-of-trade at which they will be willing to provide liquidity in the future. We call such randomness liquidity risk. We argue that liquidity risk is an important source of asymmetric information in addition to private information about future cash flows. We model the endogenous dynamics of liquidity risk, the risk premisum for bearing liquidity risk, and the role of market trading in the liquidity discovery process through which investors learn about their counterparties' preferences and their future demands for securities. We show that market liquidity is a forward-looking predictor of future risk and, as such, is prices. Our model also provides rational explanations for "prices support levels" and "flights to quality."
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Bibliographic InfoPaper provided by Carnegie Mellon University, Tepper School of Business in its series GSIA Working Papers with number 2004-10.
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Postal: Tepper School of Business, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, PA 15213-3890
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Other versions of this item:
- Burton Hollifield & Michael Gallmeyer & Duane Seppi, 2004. "Liquidity Discovery and Asset Pricing," 2004 Meeting Papers 136a, Society for Economic Dynamics.
- Duane Seppi & Michael Gallmeyer & Burton Hollifield, 2004. "Liquidity Discovery and Asset Pricing," Econometric Society 2004 North American Summer Meetings 525, Econometric Society.
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-12-12 (All new papers)
- NEP-FIN-2004-12-12 (Finance)
- NEP-FIN-2004-12-15 (Finance)
- NEP-FMK-2005-03-03 (Financial Markets)
- NEP-RMG-2004-12-12 (Risk Management)
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- Favero, Carlo A & Pagano, Marco & von Thadden, Ernst-Ludwig, 2008.
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CEPR Discussion Papers
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