When failure is an option: Fragile liquidity in over-the-counter markets

Terrence Hendershott, Dan Li, Dmitry Livdan and Norman Schürhoff
Authors registered in the RePEc Author Service: Norman Schuerhoff

Journal of Financial Economics, 2024, vol. 157, issue C

Abstract: Markets can give false impressions of liquidity and stability if failed attempts to trade are ignored. For collateralized loan obligations, we quantify this bias by estimating the total cost of immediacy (TCI) which incorporates failure rates and failure costs. TCI is substantially higher than the observed cost, 0.3–3.8% versus 0.04–0.12% across credit-quality tranches because trade failures are frequent, failure costs are large, and failure costs and rates are correlated. TCI is almost double the realized gains from trade for low-rated tranches. Overall, auction-based over-the-counter markets become illiquid and fragile, especially during stressful periods for low-rated assets.

Keywords: Liquidity; Fragility; Cost of immediacy; Securities auctions; Over-the-counter markets; Structured products; Collateralized loan obligations (search for similar items in EconPapers)
JEL-codes: G12 G14 G24 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:157:y:2024:i:c:s0304405x24000825

DOI: 10.1016/j.jfineco.2024.103859

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