On Market Liquidity and Liquid Balances
31 Pages Posted: 25 Jan 2006
Date Written: November 2005
Abstract
Are securities markets more liquid when the economy is more liquid? If so, why? One possibility is that market depth depends on credit constrained intermediaries. This paper offers another explanation, which does not involve frictions or market segmentation. Measuring market illiquidity by the slope of the representative agent's demand curve for a risky asset, I show that this slope is steeper when money-like investments (or liquid balance) represent less of an economy's assets. That is because an exchange of shares for money in such a state induces greater intertemporal substitution than it does when there are more liquid balances. Thus securities' illiquidity fluctuates naturally with the level of real liquidity. This observation has important implication for understanding the causes of market fragility.
Keywords: liquidity, liquidity risk, savings, asset pricing
JEL Classification: D91, E21, E44, E52, G12
Suggested Citation: Suggested Citation
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