This paper analyzes systematic variations in market liquidity that arise in standard representative-agent endowment economies. I introduce a natural definition of liquidity that applies whether or not the model supports actual trade in securities. This fundamental endogenous liquidity is driven by the underlying risk dynamics of the economy, and hence does not depend on whatever drives demand f...

We develop a structural bond valuation model to simultaneously capture liquidity and credit risk. Our model implies that renegotiation in financial distress is influenced by the illiquidity of the market for distressed debt. As default becomes more likely, the components of bond yield spreads attributable to illiquidity increase. When we consider finite maturity debt, we find decreasing and con...

The outbreak of the recent financial crisis reveals significant problems in current bank practices in conventional liquidity risk management. To avoid catastrophic consequences, a holistic view, which captures the dynamic interactions between liquidity and other financial variables, should be taken to help banks make business decisions. However, few studies in the literature have addressed this...

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 ...

We investigate the evolution of market liquidity risk and its spillover effect across 50 countries using daily data from 1995 to 2010. From recent financial crisis, liquidity becomes an important issue for both developed and emerging countries. Lee (2011) showed that liquidity risk premium vary significantly differently in international financial markets. By employing four different types of li...

This study develops a stress-testing framework to assess liquidity risk of banks, where liquidity and default risks can stem from the crystallisation of market risk arising from a prolonged period of negative asset price shocks. In the framework, exogenous asset price shocks increase banks’ liquidity risk through three channels. First, severe mark-to-market losses on the banks’ assets increase ...

In this paper we examine pure limit order markets in order to find out how different trading strategies affect the shape of the order book. We concentrate on liquidity trading, which implies that any new information that would influence the fundamental value of the traded asset is excluded. The humped shape of the order book is a stylized fact studied in the literature. We build a simulation mo...

This paper develops a structured dynamic factor model for the spreads between London Interbank O¤ered Rate (LIBOR) and overnight index swap (OIS) rates for a panel of banks. Our model involves latent factors which re‡ect liquidity and credit risk. Our empirical results show that surges in the short term LIBOR-OIS spreads during the 2007-2009 …nancial crisis were largely driven by liquidity risk...

Almost everyone believes that the US current account deficit must eventually end, and that this end will involve dollar depreciation. However, many believe that this depreciation will take place gradually. This paper shows that any process of gradual dollar decline fast enough to prevent the accumulation of implausible levels of US external debt would impose capital losses on investors much lar...