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Endogenous Liquidity and Contagion

Author

Listed:
  • Jean-Pierre Zigrand

  • Rohit Rahi

Abstract

Market liquidity is typically characterized by a number of ad hoc metrics, such as depth, volume, bid-ask spreads etc. No general coherent definition seems to exist, and few attempts have been made to justify the existing metrics on welfare grounds. In this paper we propose a welfare-based definition of liquidity and characterize its relationship to the usual proxies. Our analysis rests on a general equilibrium model with multiple assets and restricted investor participation. Strategic intermediaries pursue profit opportunities by providing intermediation services (i.e. “liquidity¶) in exchange for an endogenous fee. Our model is well-suited to study the contagion-like effects of liquidity shocks.

Suggested Citation

  • Jean-Pierre Zigrand & Rohit Rahi, 2009. "Endogenous Liquidity and Contagion," FMG Discussion Papers dp637, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp637
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    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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