Abstract
This study analyzes the efficiency of liquidity flows in stabilizing distressed markets from a theoretical perspective. We show that even in the event of a major negative market shock, a financial institution can increase its investment in the market when there is a strong incentive for arbitrage profit. However, the institution may choose to reduce its investment if the fear from liquidity risk exceeds the arbitrage incentive. In addition, our model reveals a positive relationship between funding liquidity and market liquidity. Our findings help to explain several financial issues in distressed markets, including the flight to quality, liquidity dry-ups, asset fire sales, and market shock amplifications.
| Original language | English |
|---|---|
| Pages (from-to) | 1-12 |
| Number of pages | 12 |
| Journal | Emerging Markets Finance and Trade |
| Volume | 55 |
| Issue number | 1 |
| DOIs | |
| State | Published - 2 Jan 2019 |
Keywords
- arbitrage profit
- distressed market
- flight to quality
- liquidity risk
- market efficiency