Liquidity and Risk Management
This paper provides a model of the interaction between risk-management practices and market liquidity. On one hand, tighter risk management reduces the maximum position an institution can take, thus the amount of liquidity it can offer to the market. On the other hand, risk managers can take into account that lower liquidity amplifies the effective risk of a position by lengthening the time it takes to sell it. The main result of the paper is that a feedback effect can arise: tighter risk management reduces liquidity, which in turn leads to tighter risk management, etc. This can help explain sudden drops in liquidity and, since liquidity is priced, in prices in connection with increased volatility or decreased risk-bearing capacity.
(This abstract was borrowed from another version of this item.)
Volume (Year): 97 (2007)
Issue (Month): 2 (May)
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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.:
- Lasse Heje Pederson & Markus K Brunnermeier, 2007.
"Market Liquidity and Funding Liquidity,"
FMG Discussion Papers
dp580, Financial Markets Group.
- Markus K. Brunnermeier & Lasse Heje Pedersen, 2007. "Market liquidity and funding liquidity," LSE Research Online Documents on Economics 24478, London School of Economics and Political Science, LSE Library.
- Markus K. Brunnermeier & Lasse Heje Pedersen, 2007. "Market Liquidity and Funding Liquidity," NBER Working Papers 12939, National Bureau of Economic Research, Inc.
- Brunnermeier, Markus K & Pedersen, Lasse Heje, 2007. "Market Liquidity and Funding Liquidity," CEPR Discussion Papers 6179, C.E.P.R. Discussion Papers.
- Darrell Duffie, 2012.
in: Dark Markets: Asset Pricing and Information Transmission in Over-the-Counter Markets
Princeton University Press.
- Pierre-Olivier Weill, 2004.
"Leaning against the wind,"
2004 Meeting Papers
382, Society for Economic Dynamics.
- Mitchel Y. Abolafia (ed.), 2005. "Markets," Books, Edward Elgar Publishing, number 2788.
- Duffie, Darrell & Garleanu, Nicolae Bogdan & Pedersen, Lasse Heje, 2006.
"Valuation in Over-the-Counter Markets,"
CEPR Discussion Papers
5491, C.E.P.R. Discussion Papers.
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