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Learning from Prices, Liquidity Spillovers, and Market Segmentation

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  • Giovanni Cespa

    ()
    (Cass Business School, CSEF, and CEPR)

  • Thierry Focault

    (HEC, School of Management, Paris, GREGHEC, and CEPR)

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    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 Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 284.

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    Date of creation: 18 Apr 2011
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    Handle: RePEc:sef:csefwp:284

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    Related research

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

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