Discussion Paper Details

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Title: Learning from Prices, Liquidity Spillovers, and Market Segmentation

Author(s): Giovanni Cespa and Thierry Foucault

Publication Date: April 2011

Keyword(s): Colocation, Contagion, Liquidity Risk, Liquidity spillovers, Transparency and Value of price information

Programme Area(s): Financial Economics

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.

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Bibliographic Reference

Cespa, G and Foucault, T. 2011. 'Learning from Prices, Liquidity Spillovers, and Market Segmentation'. London, Centre for Economic Policy Research.