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The Paradox Of Liquidity

  • Stewart C. Myers
  • Raghuram G. Rajan

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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Article provided by MIT Press in its journal The Quarterly Journal of Economics.

Volume (Year): 113 (1998)
Issue (Month): 3 (August)
Pages: 733-771

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Handle: RePEc:tpr:qjecon:v:113:y:1998:i:3:p:733-771
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  1. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
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  17. Diamond, Douglas W, 1991. "Debt Maturity Structure and Liquidity Risk," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 709-37, August.
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