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Liquidity and Financial Market Stability

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Author Info
Maureen O'Hara () (Cornell University)
Abstract

Liquidity occupies a central importance for many areas of finance. But there are very disparate views of liquidity, and correspondingly many different policy implications attached to these views. In this paper, I consider the many faces of liquidity and their implications for financial market stability. In particular, I focus on the traditional economics view of liquidity as destabilizing and the more positive microstructure view of liquidity as a positive attribute for both traders and markets. I outline the various policy prescriptions for market stability that arise from these disparate views, and how they relate to current market developments. I then consider a new view of liquidity deriving from the new research on uncertainty aversion, and I detail what this approach implies for market stability. I conclude by summarizing the implications for public policy and central bank behavior toward liquidity.

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Paper provided by National Bank of Belgium in its series Research series with number 200405-11.

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Length: 19 pages
Date of creation: May 2004
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Handle: RePEc:nbb:reswpp:200405-11

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  1. Luc Aucremanne & Guy Brys & Mia Hubert & Peter J. Rousseeuw & Anja Struyf, 2002. "Inflation, relative prices and nominal rigidities," Research series 200205-1, National Bank of Belgium. [Downloadable!]
  2. Stephen J. Turnovsky, 2000. "Growth in an open economy: some recent developments," Research series 200005-1, National Bank of Belgium. [Downloadable!]
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  3. Philippe Jeanfils, 2000. "A model with explicit expectations for Belgium," Research series 200003-3, National Bank of Belgium. [Downloadable!]
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  4. Paul Masson, 2000. "Fiscal policy and growth in the context of European integration," Research series 200005-3, National Bank of Belgium. [Downloadable!]
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  5. Patrick Bisciari, 2001. "Nouvelle économie," Documents series 200104, National Bank of Belgium. [Downloadable!]
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  6. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09. [Downloadable!] (restricted)
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  7. Danny Cassimon & Peter-Jan Engelen & Hilde Meersman & Martine Van Wouwe, 2002. "Investment, uncertainty and irreversibility: evidence from belgian accounting data," Research series 200205-4, National Bank of Belgium. [Downloadable!]
  8. Charles Wyplosz, 2000. "Economic growth and the labor markets: Europe's challenge," Research series 200005-4, National Bank of Belgium. [Downloadable!]
  9. Ronald MacDonald, 2000. "The role of the exchange rate in economic growth: a euro-zone perspective," Research series 200005-5, National Bank of Belgium. [Downloadable!]
  10. Alain Nyssens & Paul Butzen & Patrick Bisciari, 2000. "Performances économiques des Etats-Unis dans les années nonante," Documents series 200003-3, National Bank of Belgium. [Downloadable!]
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  11. Michele Cincera, 2002. "Financing constraints, fixed capital and R&D investment decisions of belgian firms," Research series 200205-13, National Bank of Belgium. [Downloadable!]
  12. Philippe Jeanfils, 2001. "A guided tour of the world of rational expectations models and optimal policies," Research series 2001-06, National Bank of Belgium. [Downloadable!]
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  13. Paul Butzen & Catherine Fuss & Philip Vermeulen, 2002. "The impact of uncertainty on investment plans," Research series 200205-5, National Bank of Belgium. [Downloadable!]
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