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Learning from Prices, Liquidity Spillovers, and Market Segmentation

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  • Cespa, Giovanni
  • Foucault, Thierry

Abstract

We describe a new mechanism that explains the transmission of liquidity shocks from one security to another ("liquidity spillovers"). Dealers use prices of other securities as a source of information. As prices of less liquid securities convey less precise information, a drop in liquidity for one security raises the uncertainty for dealers in other securities, thereby affecting their liquidity. The direction of liquidity spillovers is positive if the fraction of dealers with price information on other securities is high enough. Otherwise liquidity spillovers can be negative. For some parameters, the value of price information increases with the number of dealers obtaining this information. In this case, related securities can appear segmented, even if the cost of price information is small.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8350.

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Date of creation: Apr 2011
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Handle: RePEc:cpr:ceprdp:8350

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Related research

Keywords: Colocation; Contagion; Liquidity Risk; Liquidity spillovers; Transparency; Value of price information;

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References

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  1. Cespa, Giovanni & Foucault, Thierry, 2008. "Insiders-Outsiders, Transparency and the Value of the Ticker," CEPR Discussion Papers 6794, C.E.P.R. Discussion Papers.
  2. Giovanni Cespa, 2004. "A Comparison of Stock Market Mechanisms," RAND Journal of Economics, The RAND Corporation, vol. 35(4), pages 803-824, Winter.
  3. Barlevy, Gadi & Veronesi, Pietro, 2000. "Information Acquisition in Financial Markets," Review of Economic Studies, Wiley Blackwell, vol. 67(1), pages 79-90, January.
  4. Jayant Vivek Ganguli & Liyan Yang, 2009. "Complementarities, Multiplicity, and Supply Information," Journal of the European Economic Association, MIT Press, vol. 7(1), pages 90-115, 03.
  5. Caballe, Jordi & Krishnan, Murugappa, 1994. "Imperfect Competition in a Multi-security Market with Risk Neutrality," Econometrica, Econometric Society, vol. 62(3), pages 695-704, May.
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Cited by:
  1. Liyan Yang & Itay Goldstein, 2012. "Information Diversity and Market Efficiency Spirals," 2012 Meeting Papers 349, Society for Economic Dynamics.
  2. Dimitri Vayanos & Jiang Wang, 2012. "Market Liquidity - Theory and Empirical Evidence," FMG Discussion Papers dp709, Financial Markets Group.
  3. Ben-David, Itzhak & Franzoni, Francesco & Moussawi, Rabih, 2011. "ETFs, Arbitrage, and Contagion," Working Paper Series 2011-20, Ohio State University, Charles A. Dice Center for Research in Financial Economics.

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