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Learning from Prices, Liquidity Spillovers, and Market Segmentation

58 Pages Posted: 20 Apr 2011  

Giovanni Cespa

Cass Business School; Centre for Economic Policy Research (CEPR)

Thierry Foucault

HEC Paris - Finance Department

Multiple version iconThere are 2 versions of this paper

Date Written: April 2011

Abstract

We describe a new mechanism that explains the transmission of liquidity shocks from one security to another ("liquidity spillovers"). Dealers use prices of other securities as a source of information. As prices of less liquid securities convey less precise information, a drop in liquidity for one security raises the uncertainty for dealers in other securities, thereby affecting their liquidity. The direction of liquidity spillovers is positive if the fraction of dealers with price information on other securities is high enough. Otherwise liquidity spillovers can be negative. For some parameters, the value of price information increases with the number of dealers obtaining this information. In this case, related securities can appear segmented, even if the cost of price information is small.

Keywords: Colocation, Contagion, Liquidity Risk, Liquidity spillovers, Transparency, Value of price information

JEL Classification: G10, G12, G14

Suggested Citation

Cespa, Giovanni and Foucault, Thierry, Learning from Prices, Liquidity Spillovers, and Market Segmentation (April 2011). CEPR Discussion Paper No. DP8350. Available at SSRN: https://ssrn.com/abstract=1815845

Giovanni Cespa (Contact Author)

Cass Business School ( email )

106, Bunhill Row
London, EC1Y 8TZ
Great Britain
+44(0)2040708704 (Phone)

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Thierry Foucault

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France
(33)139679569 (Phone)
(33)139677085 (Fax)

HOME PAGE: http://thierryfoucault.com/

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