Abstract
This paper presents a model of liquidity and volatility in which investors extrapolate recent price movements to forecast the volatility of a risky asset. High perceived volatility leads to high risk premium, low current return, low risk-free rate and illiquid markets. Illiquidity amplifies supply shocks, increasing realized volatility of prices, which feeds into subsequent volatility forecasts. As a result, clustering of volatility and liquidity arises endogenously. The model helps to unify several known facts about liquidity and volatility, and I find support for its new prediction which links misperception of volatility to liquidity.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
