Flight to Quality, Flight to Liquidity, and the Pricing of Risk

Dimitri Vayanos

No 10327, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We propose a dynamic equilibrium model of a multi-asset market with stochastic volatility and transaction costs. Our key assumption is that investors are fund managers, subject to withdrawals when fund performance falls below a threshold. This generates a preference for liquidity that is time-varying and increasing with volatility. We show that during volatile times, assets' liquidity premia increase, investors become more risk averse, assets become more negatively correlated with volatility, assets' pairwise correlations can increase, and illiquid assets' market betas increase. Moreover, an unconditional CAPM can understate the risk of illiquid assets because these assets become riskier when investors are the most risk averse.

JEL-codes: G1 G2 (search for similar items in EconPapers)
Date: 2004-02
New Economics Papers: this item is included in nep-fin and nep-fmk
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (311)

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Working Paper: Flight to quality, flight to liquidity, and the pricing of risk (2004)
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