NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Liquidity Risk and the Dynamics of Arbitrage Capital

Dimitri Vayanos, Peter Kondor

NBER Working Paper No. 19931
Issued in February 2014
NBER Program(s):   AP

We develop a dynamic model of liquidity provision, in which hedgers can trade multiple risky assets with arbitrageurs. We compute the equilibrium in closed form when arbitrageurs' utility over consumption is logarithmic or risk-neutral with a non-negativity constraint. Liquidity is increasing in arbitrageur wealth, while asset volatilities, correlations, and expected returns are hump-shaped. Liquidity is a priced risk factor: assets that suffer the most when liquidity decreases, e.g., those with volatile cashflows or in high supply by hedgers, offer the highest expected returns. When hedging needs are strong, arbitrageurs can choose to provide less liquidity even though liquidity provision is more profitable.

You may purchase this paper on-line in .pdf format from SSRN.com ($5) for electronic delivery.

Information about Free Papers

You should expect a free download if you are a subscriber, a corporate associate of the NBER, a journalist, an employee of the U.S. federal government with a ".GOV" domain name, or a resident of nearly any developing country or transition economy.

If you usually get free papers at work/university but do not at home, you can either connect to your work VPN or proxy (if any) or elect to have a link to the paper emailed to your work email address below. The email address must be connected to a subscribing college, university, or other subscribing institution. Gmail and other free email addresses will not have access.

E-mail:

Acknowledgments

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w19931

Users who downloaded this paper also downloaded these:
Gabaix and Maggiori w19854 International Liquidity and Exchange Rate Dynamics
Caballero and Farhi w19927 The Safety Trap
Favilukis, Ludvigson, and Van Nieuwerburgh w19917 Foreign Ownership of U.S. Safe Assets: Good or Bad?
Duffie, Scheicher, and Vuillemey w19890 Central Clearing and Collateral Demand
Ljungqvist and Qian w19834 How Constraining Are Limits to Arbitrage? Evidence from a Recent Financial Innovation
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us