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Contrary to most common theories that greater liquidity is necessarily better for financial markets overall, Ben-Gurion University of the Negev (BGU) researchers contend in a new paper that liquidity comes at cost: it increases market risk.
Prof. Haim Kedar-Levy of the BGU Department of Management and Prof. Shmuel Hauser of the Department of Business Administration in the Guilford Glazer Faculty of Business and Management presented their theory in "Liquidity might come at cost: The role of heterogeneous preferences" at the 25th Annual Conference of the Multinational Finance Society held in Budapest, Hungary.
Literature - Liquidity - Assets - Stock - Attribute
Financial literature contends that liquidity of specific assets, such as a stock, is an important and positive attribute that can reduce risk and add value to the stock. Kedar-Levy and Hauser agree, however their findings on the impact of liquidity on the whole market is different.
"The model we developed is richer than the classic theory because, among other reasons, it takes into account a more realistic treatment of financial markets in which various investors have different investment strategies," the researchers say. "Investors differ in the amount of risk they are willing to assume, and therefore choose different proportions of investments in risky assets, such as equities."
Scenario - Study - Liquid
In this more realistic scenario, the study shows that the more liquid...
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