Dealer Attention, Liquidity Spillovers, and Endogenous Market Segmentation
Speaker
Abstract
| We describe a new mechanism that explains the transmission of liquidity shocks from one security to another ("liquidity spillovers"). We consider a model in which two securi- ties are traded by two different pools of risk averse dealers. The payoffs of these securities are correlated. Hence, dealers in one security can learn information from the price of the other security. As securities' prices are noisier when markets are less liquid, a decline in liquidity in one market spreads to the other market. This spillover mechanism relies on dealer attention to the price of other securities. Thus, we also analyze how the cost of attention a ects market liquidity. Interestingly, a reduction in the cost of attention does not necessarily improve liquidity if too few dealers pay this cost. Moreover, for some pa- rameter values, attention decisions to prices by di erent dealers are complements. Thus, multiple equilibria with varying levels of attention and liquidity can emerge for the same values of the fundamentals. |
Download paper  |
| Contact information: |
| Viorel Roscovan |
