Illiquidity and All Its Friends
- (pp. 287-325)
Abstract
The recent crisis was characterized by massive illiquidity. This paper reviews what we know and don't know about illiquidity and all its friends: market freezes, fire sales, contagion, and ultimately insolvencies and bailouts. It first explains why liquidity cannot easily be apprehended through a single statistic, and asks whether liquidity should be regulated given that a capital adequacy requirement is already in place. The paper then analyzes market breakdowns due to either adverse selection or shortages of financial muscle, and explains why such breakdowns are endogenous to balance sheet choices and to information acquisition. It then looks at what economics can contribute to the debate on systemic risk and its containment. Finally, the paper takes a macroeconomic perspective, discusses shortages of aggregate liquidity, and analyzes how market value accounting and capital adequacy should react to asset prices. It concludes with a topical form of liquidity provision, monetary bailouts and recapitalizations, and analyzes optimal combinations thereof; it stresses the need for macro-prudential policies. ( JEL E44, G01, G21, G28, G32, L51)Citation
Tirole, Jean. 2011. "Illiquidity and All Its Friends." Journal of Economic Literature, 49 (2): 287-325. DOI: 10.1257/jel.49.2.287JEL Classification
- E44 Financial Markets and the Macroeconomy
- G01 Financial Crises
- G21 Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 Financial Institutions and Services: Government Policy and Regulation
- G32 Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
- L51 Economics of Regulation