The events following Lehman's failure in 2008 and the current turmoil emanating from Europe highlight the structural vulnerabilities of short-term credit markets and the role of central banks as ...back-stop liquidity providers. The Federal Reserve's response to financial disruptions in the United States importantly included the creation of liquidity facilities. Using a differences-in-differences approach, we evaluate one of the most unusual of these interventions—the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility. We find that this facility helped stabilize asset outflows from money market funds and reduced asset-backed commercial paper yields significantly.
Portfolio Choice with Illiquid Assets Ang, Andrew; Papanikolaou, Dimitris; Westerfield, Mark M.
Management science,
11/2014, Volume:
60, Issue:
11
Journal Article
Peer reviewed
Open access
We present a model of optimal allocation to liquid and illiquid assets, where illiquidity risk results from the restriction that an asset cannot be traded for intervals of uncertain duration. ...Illiquidity risk leads to increased and state-dependent risk aversion and reduces the allocation to both liquid and illiquid risky assets. Uncertainty about the length of the illiquidity interval, as opposed to a deterministic nontrading interval, is a primary determinant of the cost of illiquidity. We allow market liquidity to vary from “normal” periods, when all assets are fully liquid, to “illiquidity crises,” when some assets can only be traded infrequently. The possibility of a liquidity crisis leads to limited arbitrage in normal times. Investors are willing to forgo 2% of their wealth to hedge against illiquidity crises occurring once every 10 years.
This paper was accepted by Itay Goldstein, finance.
Researchers have various ways to measure liquidity but most of them come with both merits and demerits. This study provides a literature review of low‐frequency liquidity measures with a primary ...focus on liquidity measurement as well as its implication on asset pricing. Based on the dimension it captures, a range of existing low‐frequency measures are divided into four categories of liquidity proxies including transaction cost, volume, price impact, and multidimension‐based measures. We review some well‐established liquidity proxies, a new bid–ask spread estimator and price impact ratios proposed recently. Finally, we discuss how good low‐frequency liquidity measures are at capturing standard liquidity benchmarks, which are constructed from high‐frequency intraday data.
Activities of international banks are at the core of discussions on the causes and effects of the global financial crisis. The International Banking Research Network (IBRN), established in 2012, ...brings together researchers from around the world with access to microdata on individual banks to investigate key issues. This paper summarizes the common methodology and results of case studies conducted in 11 countries to analyze the impact of liquidity shocks on bank lending, both domestic and foreign. Four main insights are established. First, liquidity conditions affecting parent banks transmit into both the domestic and foreign lending of these banks. Second, the ex ante balance sheet composition of banks and banks' business models influence their responses to liquidity risk. No single balance sheet characteristic consistently plays a role in liquidity risk transmission. Third, internal liquidity management within multinational banks can alter the domestic lending effects of liquidity risk. Fourth, the availability of official sector liquidity tends to reduce the adverse consequences of private liquidity conditions for bank lending during stress periods and to weaken the impact of bank balance sheet constraints.
In this paper, we investigate how the COVID-19 health crisis could affect the liquidity of listed firms across 26 countries. We stress-test three liquidity ratios for each firm with full and partial ...operating flexibility in two simulated distress scenarios corresponding to drops in sales of 50% and 75%, respectively. In the most adverse scenario, the average firm with partial operating flexibility would exhaust its cash holdings in about two years. At that point, its current liabilities would increase, on average, by eight times, suggesting that the average firm would have to resort to the debt market to prevent a liquidity crunch. Moreover, about 1/10th of all sample firms would become illiquid within six months. Finally, we study two different fiscal policies, tax deferrals and bridge loans, that governments could implement to mitigate the liquidity risk. Our analysis suggests bridge loans are more cost-effective to prevent a massive cash crunch.
•This article studies the effect of shortening settlement cycle on liquidity.•Indian markets moved stocks from T + 2 to T + 1 in multiple batches.•We show that stocks that moved to T + 1 became more ...liquid.•The improvement is greater for stocks with lower market capitalization.
Many jurisdictions across the world are considering shortening the settlement cycle in equity markets from T + 2 to T + 1 with the primary objective of promoting investor protection, reducing risk and improving efficiency. In addition to achieving these objectives, shortened settlement cycles also lower the funding liquidity demand with lower margin requirements, which could unlock liquidity in less liquid stocks. Using the data from Indian markets, which incrementally migrated securities from T + 2 to T + 1 each month, we construct a series of quasi-natural experiments and find that shorter settlement cycles improve market liquidity, and the improvement in liquidity is greater for stocks with smaller market capitalization. Shortening of settlement cycles can be a path to improving overall liquidity and widening its availability to illiquid stocks.
We develop a parsimonious liquidity-adjusted downside capital asset pricing model to investigate whether phenomena such as downward liquidity spirals and flights to liquidity impact expected asset ...returns. We find strong empirical support for the model. Downside liquidity risk (sensitivity of stock liquidity to negative market returns) has an economically meaningful return premium that is 10 times larger than its symmetric analogue. The expected liquidity level and downside market risk are also associated with meaningful return premiums. Downside liquidity risk and its associated premium are higher during periods of low marketwide liquidity and for stocks that are relatively small, illiquid, volatile, and have high book-to-market ratios. These results are consistent with investors requiring compensation for holding assets susceptible to adverse liquidity phenomena. Our findings suggest that mitigation of downside liquidity risk can lower firms’ cost of capital.
This paper was accepted by Lauren Cohen, finance
.
We study the credit supply effects of the unexpected freeze of the European interbank market, using exhaustive Portuguese loan-level data. We find that banks that rely more on interbank borrowing ...before the crisis decrease their credit supply more during the crisis. The credit supply reduction is stronger for firms that are smaller, with weaker banking relationships. Small firms cannot compensate the credit crunch with other sources of debt. Furthermore, the
impact of illiquidity on the credit crunch is stronger for less solvent banks. Finally, there are no overall positive effects of central bank liquidity, but higher hoarding of liquidity.
The Effect of Liquidity on Governance Edmans, Alex; Fang, Vivian W.; Zur, Emanuel
The Review of financial studies,
06/2013, Volume:
26, Issue:
6
Journal Article
Peer reviewed
This paper demonstrates a positive effect of stock liquidity on blockholder governance. Liquidity increases the likelihood of block formation. Conditional upon acquiring a stake, liquidity reduces ...the likelihood that the blockholder governs through voice (intervention)—as shown by the lower propensity for active investment (filing Schedule 13D) than passive investment (filing Schedule 13G). The lower frequency of activism does not reflect the abandonment of governance, but governance through the alternative channel of exit (selling one's shares): A 13G filing leads to positive announcement returns and improvements in operating performance, especially in liquid firms. Moreover, taking into account the increase in block formation, liquidity has an unconditional positive effect on voice as well as exit. We use decimalization as an exogenous shock to liquidity to identify causal effects.
We hypothesize that a source of commonality in a stock's liquidity arises from the correlated liquidity demand of the stock's investors. Focusing on correlated trading of mutual funds, we find that ...stocks with high mutual fund ownership have comovements in liquidity about twice as large as those for stocks with low mutual fund ownership. Further analysis shows that the channels for these comovements derive from both common ownership across funds and funds' correlated liquidity shocks. We obtain inferences supporting causality from an exogenous flow shock for mutual funds in the aftermath of the 2003 mutual fund scandal.
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