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Self-Fulfilling Liquidity Dry-Ups

Malherbe, F; (2014) Self-Fulfilling Liquidity Dry-Ups. The Journal of Finance , 69 (2) pp. 947-970. 10.1111/jofi.12063. Green open access

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Abstract

I analyze a model in which holding cash imposes a negative externality: it worsens future adverse selection in markets for long-term assets, which impairs their role for liquidity provision. Adverse selection worsens when potential sellers of long-term assets hold more cash because then fewer sales reflect cash needs, and proportionally more sales reflect private information. Moreover, future market illiquidity makes current cash holding more appealing. This feedback effect may result in hoarding behavior and a market breakdown, which I interpret as a self-fulfilling liquidity dry-up. This mechanism suggests that imposing liquidity requirements on financial institutions may backfire.

Type: Article
Title: Self-Fulfilling Liquidity Dry-Ups
Open access status: An open access version is available from UCL Discovery
DOI: 10.1111/jofi.12063
Publisher version: https://doi.org/10.1111/jofi.12063
Language: English
Additional information: This version is the version of record. For information on re-use, please refer to the publisher’s terms and conditions.
UCL classification: UCL
UCL > Provost and Vice Provost Offices > UCL BEAMS
UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Engineering Science
UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Engineering Science > UCL School of Management
URI: https://discovery.ucl.ac.uk/id/eprint/10055453
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