Self-Fulfilling Liquidity and the Coordination Premium
Posted: 19 Jan 2005
Date Written: August 2004
Abstract
This paper deals with liquidity as a pure self-fulfilling phenomenon. If investors who value liquidity expect an asset to be actively traded, they are willing to trade it, thereby vindicating their beliefs in a liquid asset. While this primary notion of liquidity is important in monetary and financial economics, its pricing implications are unclear because formal models of self-fulfilling liquidity typically feature multiple equilibria. Applying global game techniques to a simple model of self-fulfilling liquidity, we find a unique liquidity premium. This enables us to derive the implications of this notion of liquidity on the price, design, and diffusion of newly issued securities.
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