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Liquidity and Risk Management
Abstract
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.
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Citations
Cited by
Market Liquidity and Funding Liquidity
Brunnermeier, M. K., & Pedersen, L. H. (2009) · Review of Financial Studies · doi:10.1093/rfs/hhn098 · Cited by 4,835
Self-citationUnderstanding commonality in liquidity around the world
Karolyi, G. A., Lee, K.-H., & van Dijk, M. A. (2012) · Journal of Financial Economics · doi:10.1016/j.jfineco.2011.12.008 · Cited by 720
Stock Market Declines and Liquidity
HAMEED, A., KANG, W., & VISWANATHAN, S. (2010) · The Journal of Finance · doi:10.1111/j.1540-6261.2009.01529.x · Cited by 623
Investors' Horizons and the Amplification of Market Shocks
Cella, C., Ellul, A., & Giannetti, M. (2013) · Review of Financial Studies · doi:10.1093/rfs/hht023 · Cited by 330
Regulatory Pressure and Fire Sales in the Corporate Bond Market
Ellul, A., Jotikasthira, P., & Lundblad, C. T. (2010) · SSRN Electronic Journal · doi:10.2139/ssrn.1362182 · Cited by 262
Metadata
- Authors
- Gârleanu, N., & Pedersen, L. H.
- Venue
- American Economic Review
- Publisher
- American Economic Association
- Published
- 2007-04-01
- Volume
- 97
- Issue
- 2
- Pages
- 193-197
- ISSN
- 0002-8282 (ISSN-L)
- OpenAlex
- W3123254098
- Cited by
- 170
- References
- 0
- FWCI
- 11.81
- Type
- journal article
- Language
- en
- Open access
- closed
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- CoChat. (2026). Citation check: Liquidity and Risk Management. https://app.cochat.ai/papers/10.1257/aer.97.2.193
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- Gârleanu, N., & Pedersen, L. H. (2007). Liquidity and Risk Management. American Economic Review. https://doi.org/10.1257/aer.97.2.193
Data sources
Bibliographic data: Semantic Scholar, OpenAlex, Crossref.
Contains information from the Semantic Scholar Academic Graph Datasets, made available under the ODC Attribution License (ODC-BY 1.0).
Semantic Scholar’s data is described in: Kinney, R., et al. (2023). The Semantic Scholar Open Data Platform. arXiv:2301.10140.
