Book contents
- Frontmatter
- Contents
- Acknowledgments
- Introduction and Overview of the Book
- Part I The Effect of Liquidity Costs on Securities Prices and Returns
- Part II Liquidity Risk
- Part III Liquidity Crises
- Introduction and Overview
- Chapter 6 Market Liquidity and Funding Liquidity
- Market Liquidity and Funding Liquidity*
- Chapter 7 Liquidity and the 1987 Stock Market Crash
- Chapter 8 Slow Moving Capital
- References for Introductions and Summaries
- Index
Chapter 8 - Slow Moving Capital
Summary and Implications
Published online by Cambridge University Press: 05 December 2012
- Frontmatter
- Contents
- Acknowledgments
- Introduction and Overview of the Book
- Part I The Effect of Liquidity Costs on Securities Prices and Returns
- Part II Liquidity Risk
- Part III Liquidity Crises
- Introduction and Overview
- Chapter 6 Market Liquidity and Funding Liquidity
- Market Liquidity and Funding Liquidity*
- Chapter 7 Liquidity and the 1987 Stock Market Crash
- Chapter 8 Slow Moving Capital
- References for Introductions and Summaries
- Index
Summary
This article illustrates empirically how liquidity spirals affect prices during liquidity crises, namely, those of the convertible bond market in 2005 and 1998, and of the merger market in 1987. Convertible bonds are illiquid, and convertible bond hedge funds seek to earn the associated liquidity premium. When these hedge funds face funding problems, liquidity spirals cause significant sell-offs and price drops.
An example of this occurred in the first quarter of 2005, when more than 20% of the capital was redeemed from convertible bond hedge funds, which were therefore forced to sell large parts of their levered convertible bond holdings. The sell-offs led to price drops, requiring further sell-offs by the funds and increasing illiquidity. Convertible bonds ultimately cheapened 3% relative to their theoretical full-liquidity value, which can be estimated, because convertible bonds are derivatives. This was a large move, given the relatively low risk of these instruments and their close ties to the underlying stocks that were not affected. Levered convertible bond arbitrage lost about 7% and, as the situation stabilized and recovered, the strategy made back 15%.
- Type
- Chapter
- Information
- Market LiquidityAsset Pricing, Risk, and Crises, pp. 258 - 270Publisher: Cambridge University PressPrint publication year: 2012