Flight to Quality, Flight to Liquidity, and the Pricing of Risk / Dimitri Vayanos.

Format:

Book

Author/Creator:

Vayanos, Dimitri.

Contributor:

National Bureau of Economic Research.

Series:

Working Paper Series (National Bureau of Economic Research) no. w10327.

NBER working paper series no. w10327

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2004.

Summary:

We propose a dynamic equilibrium model of a multi-asset market with stochastic volatility and transaction costs. Our key assumption is that investors are fund managers, subject to withdrawals when fund performance falls below a threshold. This generates a preference for liquidity that is time-varying and increasing with volatility. We show that during volatile times, assets' liquidity premia increase, investors become more risk averse, assets become more negatively correlated with volatility, assets' pairwise correlations can increase, and illiquid assets' market betas increase. Moreover, an unconditional CAPM can understate the risk of illiquid assets because these assets become riskier when investors are the most risk averse.

Notes:

Print version record

February 2004.