Changes in liquidity risk, Financial Management

Liquidity risk tends to change as and when there exists a change in the spread between the bid and the ask price. Market liquidity change is a matter of concern for investors who propose to invest in the new complex bond structures. Initially  there are only a few dealers making the market in a new type of bond structure. If the structure becomes popular, more dealers enter the market and hence increase the liquidity. But if the structure proves to be unattractive, it would result in exit of existing dealers and also in the widening of bid-ask spread.

For example, in 1994, one sector of the mortgage-backed securities market, called the derivatives mortgage market, saw the collapse of an important investor (a hedge fund) and the resulting exit from the market of several dealers. As a result, liquidity in the market substantially declined and bid-ask spreads widened dramatically.  

Posted Date: 9/10/2012 1:27:05 AM | Location : United States

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