58 Pages Posted: 20 Apr 2011
Date Written: April 2011
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: 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
By Yakov Amihud
By Yakov Amihud
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