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- W2743950206 abstract "This article derives a theory of the origins of liquidity crises. The basic idea, which was put forth before the recent global financial crisis, is that liquidity spirals amplify a shock to the system, leading to a breakdown of market liquidity, a sharp drop in prices, and large losses by key banks and traders. Liquidity spirals evolve as follows: Banks and financial intermediaries have an initial shock to their funding, for instance, a loss on some of their security positions. This makes them reduce their trading and take smaller positions, which reduces market liquidity as order imbalances become more difficult and costly to absorb for market makers. The reduced market liquidity and associated increased volatility make it riskier to finance security positions and lead to increased margin requirements, which are set endogenously in the model (and, of course, in the real world). This is because margin requirements are set to make the lender relatively immune against a scenario in which the borrower defaults and, at the same time, the asset price drops. Since larger volatility increases the risk of a large price drop and higher illiquidity makes it costly to sell the collateral in case of default, both of these effects push lenders to increase their margin of safely, that is, the margin requirement. When margin requirements rise, intermediaries face exacerbated funding problems and are forced to de-leverage and divest their positions." @default.
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- W2743950206 date "2012-11-12" @default.
- W2743950206 modified "2023-09-26" @default.
- W2743950206 title "Market Liquidity and Funding Liquidity" @default.
- W2743950206 doi "https://doi.org/10.1017/cbo9780511844393.013" @default.
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