Market Liquidity and Funding Liquidity

Markus Brunnermeier and Lasse Pedersen

No 6179, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We provide a model that links an asset's market liquidity - i.e., the ease with which it is traded - and traders' funding liquidity - i.e., the ease with which they can obtain funding. Traders provide market liquidity, and their ability to do so depends on their availability of funding. Conversely, traders' funding, i.e., their capital and the margins they are charged, depend on the assets' market liquidity. We show that, under certain conditions, margins are destabilizing and market liquidity and funding liquidity are mutually reinforcing, leading to liquidity spirals. The model explains the empirically documented features that market liquidity (i) can suddenly dry up, (ii) has commonality across securities, (iii) is related to volatility, (iv) is subject to 'flight to quality', and (v) comoves with the market, and it provides new testable predictions.

Keywords: Counterparty credit risk; Leverage; Liquidity risk management; Margins; Systemic risk; Value-at-risk (search for similar items in EconPapers)
JEL-codes: G1 G2 (search for similar items in EconPapers)
Date: 2007-03
New Economics Papers: this item is included in nep-cfn, nep-mst and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (101)

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Related works:
Journal Article: Market Liquidity and Funding Liquidity (2009)
Working Paper: Market liquidity and funding liquidity (2007)
Working Paper: Market Liquidity and Funding Liquidity (2007)
Working Paper: Market Liquidity and Funding Liquidity (2007)
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