TY  - JOUR
AU  - Garleanu,Nicolae B.
AU  - Pedersen,Lasse H.
TI  - Liquidity and Risk Management
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12887
PY  - 2007
Y2  - February 2007
UR  - http://www.nber.org/papers/w12887
L1  - http://www.nber.org/papers/w12887.pdf
N1  - Author contact info:
Nicolae B. Garleanu
Haas School of Business
F628
University of California, Berkeley
Berkeley, CA 94720
Tel: (1) 510 642 3421
Fax: (1) 510 643 1420
E-Mail: garleanu@haas.berkeley.edu

Lasse H. Pedersen
NYU Stern Finance
44 West Fourth Street
Suite 9-190
New York, NY 10012
Tel: 212/998-0359
Fax: 212/995-4233
E-Mail: lpederse@stern.nyu.edu
AB  - This paper provides a model of the interaction between risk-management practices and market liquidity. On one hand, tighter risk management reduces the maximum position an institution can take, thus the amount of liquidity it can offer to the market. On the other hand, risk managers can take into account that lower liquidity amplifies the effective risk of a position by lengthening the time it takes to sell it. The main result of the paper is that a feedback effect can arise: tighter risk management reduces liquidity, which in turn leads to tighter risk management, etc. This can help explain sudden drops in liquidity and, since liquidity is priced, in prices in connection with increased volatility or decreased risk-bearing capacity.
ER  -