38 Pages Posted: 3 Mar 2005 Last revised: 20 Mar 2009
Date Written: March 16, 2009
This paper provides some rational perspective for the flight-to-liquidity event. My model highlights the inherent difference in investors' investment horizon, and thus their sensitivity to changes in transaction costs in the stock and bond markets. When stock market deterioration results in higher trading costs, the existing marginal investor shifts wealth to bonds instead of remaining indifferent between stocks and bonds. At the new equilibrium, there is a higher fraction of bond ownership and a longer average investment horizon among stock holders. I demonstrate empirical evidence in strong support of the theoretical predictions and make the case for the flight-to-liquidity event as a result of investor heterogeneity in investment horizon.
Keywords: Flight to Liquidity, Flight to Quality, Investment Horizon, Transaction cost
JEL Classification: G12, G14
Suggested Citation: Suggested Citation