Working Paper: NBER ID: w21118
Authors: Pablo Kurlat
Abstract: This paper proposes a theory of liquidity dynamics. Illiquidity results from asymmetric information. Observing the historical track record teaches agents how to interpret public information and helps overcome information asymmetry. There can be an illiquidity trap: too much asymmetric information leads to the breakdown of trade, which interrupts learning and perpetuates illiquidity. Liquidity falls in response to unexpected events that lead agents to question their valuation models, especially in newer markets, may be slow to recover after a crisis and is higher in periods of stability.
Keywords: No keywords provided
JEL Codes: D82; D83; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| precision of agents' estimates of asset qualities (D80) | liquidity (E41) |
| imprecise estimates of asset qualities (D80) | breakdown of trade (F19) |
| lack of trading generates no new data for agents to learn from (D89) | perpetuation of illiquidity (G33) |
| unexpected disruptions (F69) | slow recovery of liquidity (G33) |
| traders' expertise, level of investment, and volume of trade (F10) | liquidity (E41) |