Research

Learning from prices, liquidity spillovers, and market segmentation

Dealers use prices of other securities as a source of information. As prices of less liquid securities convey less precise information, a drop in liquidity for one security raises the uncertainty for dealers in other securities, thereby affecting their liquidity.

This working paper looks at causes for the occurrence of liquidity (or illiquidity) spillovers across markets and proposes a novel theoretical explanation that provides interesting insights into recent events, for example the 'Flash Crash' of May 2010.