Advanced Search
MyIDEAS: Login to save this paper or follow this series

Flight to Quality, Flight to Liquidity, and the Pricing of Risk

Contents:

Author Info

  • Dimitri Vayanos

Abstract

We propose a dynamic equilibrium model of a multi-asset market with stochastic volatility and transaction costs. Our key assumption is that investors are fund managers, subject to withdrawals when fund performance falls below a threshold. This generates a preference for liquidity that is time-varying and increasing with volatility. We show that during volatile times, assets' liquidity premia increase, investors become more risk averse, assets become more negatively correlated with volatility, assets' pairwise correlations can increase, and illiquid assets' market betas increase. Moreover, an unconditional CAPM can understate the risk of illiquid assets because these assets become riskier when investors are the most risk averse.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.nber.org/papers/w10327.pdf
Download Restriction: no

Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10327.

as in new window
Length:
Date of creation: Feb 2004
Date of revision:
Handle: RePEc:nbr:nberwo:10327

Note: AP
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Phone: 617-868-3900
Email:
Web page: http://www.nber.org
More information through EDIRC

Related research

Keywords:

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Hentschel, Ludger & Campbell, John, 1992. "No News is Good News: An Asymmetric Model of Changing Volatility in Stock Returns," Scholarly Articles 3220232, Harvard University Department of Economics.
  2. Vayanos, Dimitri, 1998. "Transaction Costs and Asset Prices: A Dynamic Equilibrium Model," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 11(1), pages 1-58.
  3. Huberman, G. & Halka, D., 1999. "Systematic Liquidity," Papers 99-9, Columbia - Graduate School of Business.
  4. James Dow & Gary Gorton, . "Noise Trading, Delegated Portfolio Management, and Economic Welfare," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 19-94, Wharton School Rodney L. White Center for Financial Research.
  5. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, American Finance Association, vol. 52(1), pages 35-55, March.
  6. Acharya, Viral V & Pedersen, Lasse Heje, 2003. "Asset Pricing with Liquidity Risk," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3749, C.E.P.R. Discussion Papers.
  7. Jean-Pierre Zigrand & Jon Danielsson, 2001. "What happens when you regulate risk?: evidence from a simple equilibrium model," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 25069, London School of Economics and Political Science, LSE Library.
  8. Basak, Suleyman & Cuoco, Domenico, 1998. "An Equilibrium Model with Restricted Stock Market Participation," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 11(2), pages 309-41.
  9. Eleswarapu, Venkat R, 1997. " Cost of Transacting and Expected Returns in the Nasdaq Market," Journal of Finance, American Finance Association, American Finance Association, vol. 52(5), pages 2113-27, December.
  10. Kamara, Avraham, 1994. "Liquidity, Taxes, and Short-Term Treasury Yields," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 29(03), pages 403-417, September.
  11. Alex Shapiro & Suleyman Basak & Anna Pavlova, 2004. "Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management," Econometric Society 2004 North American Winter Meetings 583, Econometric Society.
  12. Constantinides, George M, 1986. "Capital Market Equilibrium with Transaction Costs," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 94(4), pages 842-62, August.
  13. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, Elsevier, vol. 17(2), pages 223-249, December.
  14. Brennan, Michael J. & Subrahmanyam, Avanidhar, 1996. "Market microstructure and asset pricing: On the compensation for illiquidity in stock returns," Journal of Financial Economics, Elsevier, Elsevier, vol. 41(3), pages 441-464, July.
  15. Jean-Luc Vila & Dimitri Vayanos, 1999. "Equilibrium interest rate and liquidity premium with transaction costs," Economic Theory, Springer, Springer, vol. 13(3), pages 509-539.
  16. Hasbrouck, Joel & Seppi, Duane J., 2001. "Common factors in prices, order flows, and liquidity," Journal of Financial Economics, Elsevier, Elsevier, vol. 59(3), pages 383-411, March.
  17. Heinkel, Robert & Stoughton, Neal M, 1994. "The Dynamics of Portfolio Management Contracts," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 7(2), pages 351-87.
  18. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2004. "The Cross-Section of Volatility and Expected Returns," NBER Working Papers 10852, National Bureau of Economic Research, Inc.
  19. Starks, Laura T., 1987. "Performance Incentive Fees: An Agency Theoretic Approach," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 22(01), pages 17-32, March.
  20. Ravi Jagannathan & Zhenyu Wang, 1996. "The conditional CAPM and the cross-section of expected returns," Staff Report, Federal Reserve Bank of Minneapolis 208, Federal Reserve Bank of Minneapolis.
  21. Longstaff, Francis A, 1995. " How Much Can Marketability Affect Security Values?," Journal of Finance, American Finance Association, American Finance Association, vol. 50(5), pages 1767-74, December.
  22. Lasse Pedersen & Darrell Duffie & Nicolae Garleanu, 2004. "Valuation in Dynamic Bargaining Markets," Econometric Society 2004 North American Winter Meetings 649, Econometric Society.
  23. Myron S. Scholes, 2000. "Crisis and Risk Management," American Economic Review, American Economic Association, American Economic Association, vol. 90(2), pages 17-21, May.
  24. Francis A. Longstaff, 2004. "The Flight-to-Liquidity Premium in U.S. Treasury Bond Prices," The Journal of Business, University of Chicago Press, vol. 77(3), pages 511-526, July.
  25. Pastor, Lubos & Stambaugh, Robert F., 2003. "Liquidity Risk and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 111(3), pages 642-685, June.
  26. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
  27. Scharfstein, David. & Stein, Jeremy C., 1988. "Herd behavior and investment," Working papers WP 2062-88., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  28. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, Elsevier, vol. 5(1), pages 31-56, January.
  29. Tarun Chordia, 2001. "Market Liquidity and Trading Activity," Journal of Finance, American Finance Association, American Finance Association, vol. 56(2), pages 501-530, 04.
  30. Ang, Andrew & Chen, Joseph, 2002. "Asymmetric correlations of equity portfolios," Journal of Financial Economics, Elsevier, Elsevier, vol. 63(3), pages 443-494, March.
  31. Gur Huberman & Dominika Halka, 2001. "Systematic Liquidity," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 24(2), pages 161-178, 06.
  32. Warga, Arthur, 1992. "Bond Returns, Liquidity, and Missing Data," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 27(04), pages 605-617, December.
  33. Dasgupta, Amil & Prat, Andrea, 2003. "Trading Volume with Career Concerns," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4034, C.E.P.R. Discussion Papers.
  34. Chevalier, Judith & Ellison, Glenn, 1997. "Risk Taking by Mutual Funds as a Response to Incentives," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 105(6), pages 1167-1200, December.
  35. Allen, Franklin & Gorton, Gary, 1993. "Churning Bubbles," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 60(4), pages 813-36, October.
  36. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, Elsevier, vol. 19(1), pages 3-29, September.
  37. Brennan, Michael J., 1993. "Agency and Asset Pricing," University of California at Los Angeles, Anderson Graduate School of Management, Anderson Graduate School of Management, UCLA qt53k014sd, Anderson Graduate School of Management, UCLA.
  38. Krishnamurthy, Arvind, 2002. "The bond/old-bond spread," Journal of Financial Economics, Elsevier, Elsevier, vol. 66(2-3), pages 463-506.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:10327. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.