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The Paradox of Liquidity

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  • STEWART C. MYERS
  • RAGHURAM G. RAJAN

Abstract

The more liquid a firm's assets, the greater their value in a short-notice liquidation. It is generally thought that a firm should find it easier to raise external finance against more liquid assets. This paper focuses on the dark side of liquidity: greater asset liquidity reduces the firm's ability to commit to a specific course of action. As a result, greater asset liquidity can, in some circumstances, reduce the firm's capacity to raise external finance. Firms with "excessively" liquid assets are in the best position to finance illiquid projects. This leads us to a theory of financial intermediation and disintermediation based on the liquidity of assets. © 2000 the President and Fellows of Harvard College and the Massachusetts Institute of Technology

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Bibliographic Info

Paper provided by Center for Research in Security Prices, Graduate School of Business, University of Chicago in its series CRSP working papers with number 339.

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Date of creation: Aug 1998
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Handle: RePEc:wop:chispw:339

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  1. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1989. "Bank Monitoring and Investment: Evidence from the Changing Structure of Japanese Corporate Banking Relationships," NBER Working Papers 3079, National Bureau of Economic Research, Inc.
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  10. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
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  12. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  13. Huberman, Gur, 1984. " External Financing and Liquidity," Journal of Finance, American Finance Association, vol. 39(3), pages 895-908, July.
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