As part of the regulatory response to the recent global financial crisis, the Basel Committee on Banking Supervision (BCBS) announced a new international regulatory framework for banks, known as Basel III. One important component of Basel III is the Liquidity Coverage Ratio (LCR), which aims to ensure that banks hold a more liquid portfolio of assets and rely on the central bank for funding onl...

Predictability of Asset Returns and the Efficient Market Hypothesis This paper is concerned with empirical and theoretical basis of the Efficient Market Hypothesis (EMH). The paper begins with an overview of the statistical properties of asset returns at different frequencies (daily, weekly and monthly), and considers the evidence on return predictability, risk aversion and market efficiency. T...

The current debate about slow recovery from the Great Deflation, accompanied by persistent threat of price deflation, has highlighted the relevance of liquidity as a necessary factor to ensure stability and growth. An important branch of the literature focuses on the Safe Assets (i.e., liquid assets which market values are highly resilient in terms of goods and services), and pays special atten...

We develop a model of financial intermediation characterized by an inside agency problem such that asset managers, when they have access to high enough liquidity, “reach for yield” by overinvesting in risky assets and concurrently underinvesting in safer or medium-risk assets. The managers follow a pecking order whereby their first preference is to invest in risky assets; their second preferenc...

Using non-parametric weak separability tests that are extended to allow for measurement errors in the data, a broad group of UK monetary assets is found to be weakly separable from consumer goods and leisure over the larger part of the nineties. Financial innovations have made assets with substantial interest rate risk (e.g. unit trusts) more liquid and recent developments in monetary aggregati...

We examine the optimal design of and interaction between capital and liquidity regulations. Banks, not internalizing fire sale externalities, overinvest in risky assets and underinvest in liquid assets in the competitive equilibrium. Capital requirements can alleviate the inefficiency, but banks respond by decreasing their liquidity ratios. When capital requirements are the only available tool,...

This paper investigates the impact of asset liquidity on the valuation of corporate securities and the firm’s financing decisions. I show that asset liquidity increases debt capacity only when bond covenants restrict the disposition of assets. By contrast, I demonstrate that, with unsecured debt, greater liquidity increases credit spreads on corporate debt and reduces optimal leverage. The mode...

20% of U.S. households are “wealthy hand-to-mouth” who hold only illiquid assets. But why should they do so, since higher-yielding liquid assets are available? To rationalize this behavior, we build a life-cycle model with non-standard preferences: households are tempted to consume their liquid assets, and therefore purchase housing as a savings commitment device. As a result, they choose to be...

This paper investigates the link between the optimal level of non-financial firms’ liquid assets and uncertainty. We develop a partial equilibrium model of precautionary demand for liquid assets showing that firms alter their liquidity ratio in response to changes in either macroeconomic or idiosyncratic uncertainty. We test this hypothesis using a panel of non-financial US firms drawn from the...