Market Liquidity Asset Pricing, Risk, and Crises

This book presents the theory and evidence on the effect of market liquidity and liquidity risk on asset prices and on overall securities market performance. Illiquidity means incurring a high transaction cost, which includes a large price impact when trading and facing a long time to unload a large position. Liquidity risk is higher if a security becomes more illiquid when it needs to be traded in the future, which will raise trading cost. The book shows that higher illiquidity and greater liquidity risk reduce securities prices and raise the expected return that investors require as compensation. Aggregate market liquidity is linked to funding liquidity, which affects the provision of liquidity services. When these become constrained, there is a liquidity crisis which leads to downward price and liquidity spiral. Overall, the volume demonstrates the important role of liquidity in asset pricing.

Introduction Yakov Amihud, Haim Mendelson and Lasse Heje Pedersen; Part I. Liquidity: The Effect of Trading Costs on Securities Prices and Returns: 1. Asset pricing and the bid-ask spread Yakov Amihud and Haim Mendelson; 2. Liquidity, maturity, and the yield on US Treasury securities Yakov Amihud and Haim Mendelson; 3. Market microstructure and securities values: evidence from the Tel Aviv stock exchange Yakov Amihud, Haim Mendelson and Beni Lauterbach; Part II. Liquidity Risk: 4. Illiquidity and stock returns: cross-section and time-series effects Yakov Amihud; 5. Asset pricing with liquidity risk Viral V. Acharya and Lasse Heje Pedersen; Part III. Liquidity Crises: 6. Market liquidity and funding liquidity Markus Brunnermeier and Lasse Heje Pedersen; 7. Liquidity and the 1987 stock market crash Yakov Amihud, Haim Mendelson and Robert A. Wood; 8. Slow moving capital Mark Mitchell, Lasse Heje Pedersen and Todd Pulvino.

This book is about the pricing of liquidity in securities markets. The book then explains how liquidity crises create downward price and liquidity spirals. The analysis has implications for traders, risk managers, performance evaluation, economic policy, regulation of financial markets, management of liquidity crises and academic research.

Yakov Amihud is the Ira Rennert Professor of Finance at the Stern School of Business, New York University. His published research focuses on the effects of the liquidity of stocks and bonds on their returns and values and the design and evaluation of securities markets' trading methods and systems. On these topics, Professor Amihud has advised the New York Stock Exchange, American Stock Exchange, Chicago Board of Options Exchange, Chicago Board of Trade and other securities markets. He has published more than ninety research articles in professional journals and in books and edited and co-edited five books on securities market design, international finance, leveraged buyouts and bank mergers and acquisitions.
Haim Mendelson is the Kleiner Perkins Caufield and Byers Professor of Electronic Business and Commerce and Management, at the Graduate School of Business, Stanford University. His research interests include securities markets, electronic markets, information technology and the information industries. He was elected Distinguished Fellow of the Information Systems Society in recognition of outstanding intellectual contributions to the discipline. Professor Mendelson has published more than one hundred research papers in professional journals and has consulted for high-tech companies, financial institutions and securities markets.
Lasse Heje Pedersen is the John A. Paulson Professor of Finance and Alternative Investments at the New York University Stern School of Business and a principal at AQR Capital Management. He has been part of the Liquidity Working Group of the Federal Reserve Bank of New York, the New York Fed's Monetary Policy Panel, the Board of Directors of the American Finance Association, the Economic Advisory Boards of NASDAQ and FTSE, and associate editor at the Journal of Finance, the Journal of Economic Theory, Review of Asset Pricing Studies, and the Quarterly Journal of Economics. His research explains how crises can arise from liquidity spirals and how market and funding liquidity risks explain equity returns, bond yields, option prices, and currency crashes. Professor Pedersen received the 2011 Bernacer Prize for the best European economist under the age of 40 in macroeconomics and finance.