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The Paradox of Liquidity

Stewart C. Myers and Raghuram Rajan

The Quarterly Journal of Economics, 1998, vol. 113, issue 3, 733-771

Abstract: The more liquid a firm's assets, the greater their value in a short-notice liquidation. It is generally thought that a firm should find it easier to raise external finance against more liquid assets. This paper focuses on the dark side of liquidity: greater asset liquidity reduces the firm's ability to commit to a specific course of action. As a result, greater asset liquidity can, in some circumstances, reduce the firm's capacity to raise external finance. Firms with "excessively" liquid assets are in the best position to finance illiquid projects. This leads us to a theory of financial intermediation and disintermediation based on the liquidity of assets.

Date: 1998
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The Quarterly Journal of Economics is currently edited by Robert J. Barro, Lawrence F. Katz, Nathan Nunn, Andrei Shleifer and Stefanie Stantcheva

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