Bank of Lithuania
May 10 10:30 - 11:45

Presenter: Ji Hee Yoon (University College London)

Co-authors: Jaewon Choi, Jungsuk Han, and Sean Shin

Title: A Search-Based Theory of the Reversal of the Liquidity Premium Puzzle

Abstract: In a search-based trading model, we uncover how assets with identical fundamentals can exhibit a liquidity premium or its reversal. As trading focuses on the more liquid asset, liquidity naturally diverges. When buyers dominate, a liquidity premium arises, reflecting immediacy versus trading gains. Conversely, increased selling prompts sellers to seek higher prices for illiquid assets, reversing the liquidity premium. Our model unifies liquidity spread dynamics in normal and crisis periods, suggesting that supporting the illiquid market paradoxically benefits the liquid market and the total welfare, correcting the reversed liquidity premium.

Last update: 22-04-2024