Abstract
We provide empirical evidence that the relationship between market and funding liquidity display significant nonlinearities, consistent with theories of market trading with financially-constrained agents. Using data for the US equity market, we uncover nonlinearities that are consistent with a model with two extreme regimes: a lower regime characterized by the absence of correlation between market liquidity and funding liquidity, and an upper regime where the two variables are statistically positively correlated. Over the sample period the two variables are uncorrelated most of the time, since shocks to funding liquidity are economically small. This situation persists until agents are forced towards their capital constraints and shocks to funding liquidity becomes economically important.
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