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Liquidity and Financial Market Stability

  • Maureen O'Hara


    (Cornell University)

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    Liquidity occupies a central importance for many areas of finance. But there are very disparate views of liquidity, and correspondingly many different policy implications attached to these views. In this paper, I consider the many faces of liquidity and their implications for financial market stability. In particular, I focus on the traditional economics view of liquidity as destabilizing and the more positive microstructure view of liquidity as a positive attribute for both traders and markets. I outline the various policy prescriptions for market stability that arise from these disparate views, and how they relate to current market developments. I then consider a new view of liquidity deriving from the new research on uncertainty aversion, and I detail what this approach implies for market stability. I conclude by summarizing the implications for public policy and central bank behavior toward liquidity.

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    Paper provided by National Bank of Belgium in its series Working Paper Research with number 55.

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    Length: 19 pages
    Date of creation: May 2004
    Date of revision:
    Handle: RePEc:nbb:reswpp:200405-11
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