This paper provides a model of the interaction between risk-management practices and market liquidity. Our main finding is that a feedback effect can arise. Tighter risk management leads to market illiquidity, and this illiquidity further tightens risk management. Risk management plays a central role in institutional investors’ allocation of capital to trading. For instance, a risk manager may ...

Ambiguous private information leads to informational inefficiency of market prices in rational expectations equilibrium. This inefficiency implies lower asset prices as uninformed traders require a premium to hold assets. This premium is increasing in the riskiness of the asset and leads to excess volatility, price swings, and abrupt volatility and illiquidity variation across informational eff...

We study super-replication of European contingent claims in an illiquid market with insider information. Illiquidity is captured by quadratic transaction costs and information modeled investor who can peek into the future. Our main result describes scaling limit prices when number trading periods increases to infinity. Moreover, gives us asymptotic value being insider.

The paper models the interaction between risk taking in the financial sector and central bank policy for the case of pure illiquidity risk. It is shown that, when bad states are highly unlikely, public provision of liquidity may improve the allocation, even though it encourages more risk taking (less liquid investment) by private banks. In general, however, there is an incentive of financial in...

A method for computing forward-looking market risk premium is developed in this paper. We first derive a theoretical expression that links forward-looking risk premium to investors’ risk aversion and forward-looking volatility, skewness and kurtosis of cumulative return. In addition, investors’ risk aversion is theoretically linked to volatility spread, defined as the gap between the risk-neutr...

We use a novel framework that integrates standard asset pricing and microstructure models to study how asymmetric information, imperfect competition among market makers, and risk aversion affect equilibrium illiquidity and asset pricing. All the main results are obtained in closed-form. In our model, market power, asymmetric information, and market-making cost drive market illiquidity. This mod...

Abstract This article studies the impact of retail investors on stock liquidity during COVID-19 pandemic lockdown in spring 2020. Retail trading exhibits a sharp increase, especially among stocks with high COVID-19–related media coverage. attenuated rise illiquidity by roughly 40% but less so for high-media-attention stocks. Causality is addressed using staggered implementation stay-at-home adv...

In the model, a group of investors are invited to participate to a high-yield collective project. The project succeeds only if a minimum participation rate is reached. Before taking their decision, investors receive a vague statement about the outcome of a past investment decision. If investors believe that the message has an impact on the beliefs of the others, the problem can be analyzed as a...