Working Paper: NBER ID: w10327
Authors: Dimitri Vayanos
Abstract: We propose a dynamic equilibrium model of a multi-asset market with stochastic volatility and transaction costs. Our key assumption is that investors are fund managers, subject to withdrawals when fund performance falls below a threshold. This generates a preference for liquidity that is time-varying and increasing with volatility. We show that during volatile times, assets' liquidity premia increase, investors become more risk averse, assets become more negatively correlated with volatility, assets' pairwise correlations can increase, and illiquid assets' market betas increase. Moreover, an unconditional CAPM can understate the risk of illiquid assets because these assets become riskier when investors are the most risk averse.
Keywords: No keywords provided
JEL Codes: G1; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Volatility (E32) | Liquidity premia (G19) |
| Volatility (E32) | Market betas of illiquid assets (G19) |
| Unconditional CAPM (G19) | Risk assessment of illiquid assets (G33) |