Dynamics of Market Liquidity and Funding Liquidity during Financial Crisis, Its Resolution, and the Volcker Rule

47 Pages Posted: 16 Mar 2011 Last revised: 22 Sep 2013

See all articles by Xiankui Hu

Xiankui Hu

Arkansas State University - College of Business

Chinmay Jain

University of Ontario Institute of Technology

Pankaj K. Jain

University of Memphis - Fogelman College of Business and Economics

Date Written: July 2013

Abstract

We provide the first empirical evidence of a non-linear relationship between funding liquidity and market liquidity (FL-ML). The relationship depends on the state of business cycle, firm volatility, and the regulatory regime. Due to heightened funding constraints, equity trading costs increased twofold during the recent financial crisis; and even more for low quality firms, confirming the “flight to quality” hypothesis. The FL-ML relationship strengthens after favorable bank stress test results indicating the importance of market intermediation by bank affiliates. The relationship weakens after the enactment of the Volcker Rule as Volcker rule prohibits proprietary trading by banks.

Keywords: Financial crisis, SCAP bank stress tests, Volcker rule

JEL Classification: G1, G2

Suggested Citation

Hu, Xiankui and Jain, Chinmay and Jain, Pankaj K., Dynamics of Market Liquidity and Funding Liquidity during Financial Crisis, Its Resolution, and the Volcker Rule (July 2013). Midwest Finance Association 2012 Annual Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1787263 or http://dx.doi.org/10.2139/ssrn.1787263

Xiankui Hu (Contact Author)

Arkansas State University - College of Business ( email )

2713 Pawnee
P.O. Box 1750
Jonesboro, AR 72467-115
United States

Chinmay Jain

University of Ontario Institute of Technology ( email )

2000 Simcoe Street North
Oshawa, Ontario L1H 7K4
Canada

Pankaj K. Jain

University of Memphis - Fogelman College of Business and Economics ( email )

Memphis, TN 38152
United States

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