Mercers’ School Memorial Professor of Commerce
Michael Mainelli
“New Learning”
Liquidity:
Finance In Motion Or Evaporation?
Barnard’s Inn Hall
Holborn
London EC1N 2HH
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2007
www.gresham.ac.uk
Tel: +44 (0)20 7831-0575
Fax: +44 (0)20 7831-5208
Email : michael_mainelli@zyen.com
Outline
Fluidity in definition
Time, value, probability
and money
Settled dis-equilibria
Small holes
Liquidity and lucidity
Liquidity crises
Black holes, white bubbles
Trading on ice
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2007
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“Get a detailed grip on the big picture.”
Chao Kli Ning
Fluidity In Definition
“the probability that an asset can be
converted into an expected
amount of value within an
expected amount of time”
liquidity = certainty (value, time)
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2007
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Who Needs Liquidity?
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2007
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Caught Short (In Time)
Accounts receivable
turnover =
total credit sales
average accounts receivable
Accounts payable
turnover =
total credit purchases
average accounts payable
Inventory turnover =
total cost of sales
average inventory
Acid-test =
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2007
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Current ratio =
cash + securities + accounts receivable
current liabilities
current assets
current liabilities
Caught Short (In Value)
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2007
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Caught Off-Guard (In All Probability)
Certainty = % likelihood [value fall/rise +
time fall/rise]
Example: watch =
[£1,000 – 50%(£500),
1 week + 50%(2 weeks)] =
[£750, 2 weeks]
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2007
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Liquid Measures
Resilience
Depth
Tightness
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2007
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[Source: Holl and Winn, 1995]
Monnaie des Sources
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2007
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[Source: http://www.bankofengland.co.uk/]
Where Has All The Money Gone?
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2007
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[Source: OECD]
Back To Basics
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2007
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[Source: http://en.wikipedia.org/wiki/Supply_and_demand]
Rising Price Lifts All Boats
P
Demand
Supply
P2
P1
Q1 Q2
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2007
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Q
Liquidity P’s, T’s & Q’s
P
Demand
Supply
P2
P1
Q1 Q2
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2007
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Q
Not Smooth Curvature
P
Demand
Supply
P2
P1
Q1
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2007
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Q2
Q
Not Continuous
P
Demand
Supply
P2
P1
Q1
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2007
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Q2
T
Liquidity Clouds
Demand
Supply
P
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2007
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‘Normal’ liquidity risk
Q
Predicting Price Movements
Y Axis: Share Identification Code
X Axis: Actual & Predicted
Price Movement Bands –
the length of the yellow
link indicates the
difference between the
prediction and the actual
value - the longest links
represent the anomalous
trades
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2007
Z Axis: The Difference between Actual
& Predicted Price Movement Bands
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[Source: Z/Yen Group Limited, 2005]
Liquidity Holes
Demand
Supply
P
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2007
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Q
Small versus Large
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2007
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[Source: Z/Yen Group Limited, 2002]
Bull or Bear?
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2007
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Dark Liquidity Pools
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2007
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Liquidity or Lucidity?
Price
Formation
Liquidity
Capital at
Risk
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2007
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Spreads
Transparency
Trading
Competition
Regulation
Exchange
Competition
Volatility
Price
Formation
With Apologies To Jonathan Swift
So, financiers observe, small pools
suck larger pools’ liquidity;
yet tinier pools drain other drops,
and so on to aridity.
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2007
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Liquidity Crisis 2007?
“Water, water, everywhere, nor any beer to sink.”
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2007
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An Historical Perspective
Holy Roman Empire currency 1622
Tulips 1636
South Sea Scheme 1720
Northern Europe 1763
East India Company 1772
Emerging markets 1809-1838
Railways 1847-1873
Commodities 1890-1920
Great Crash of 1929
Bretton Woods collapse 1973
Savings & Loans 1980
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A Modern Perspective
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2007
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Third World Debt 1982
Black Monday 1987
Junk Bonds 1988
Japanese Bubble 1990s
US Bond Crash 1994
Mexican Crisis 1995
Asian Crisis 1997
Russian Crisis 1998
Long Term Capital Management 1998
Dotcom Crash 2000
September 11 Disruption 2001
Argentine Crisis 2002
Credit Crunch 2007
Bubble, Bubble, Toil and Trouble
Hyman Minsky’s Waterfall
Hedge
Speculative
Ponzi
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2007
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Ponzi Borrowers
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2007
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Black Holes and White Bubbles
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2007
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Modelling Financial Black Holes
P
Demand
Supply
P2
P1
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2007
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Q
Black Hole ‘Event Horizon’
Simple Really
Brasil, India, Russia, China
economic activity
goods
companies
consumers
markets
access
characteristics
confidence &
trust
savings
liquidity =
certainty (value, timing)
assets
property
credit:
default rates &
rating agencies
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2007
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financial
institutions
leverage
regulators
equities
commodities
money supply
Avoiding Liquidity Traps
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2007
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[Source: www.moneyfiles.org]
Discussion
1.
2.
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2007
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Are all liquidity
crises unique, or
irrelevant, or
useful - or are
things different
today?
When new
markets emerge,
from where does
the liquidity
come?
Liquidity:
Finance In Motion Or Evaporation?
Thank you!
© Gresham College
2007
www.gresham.ac.uk
“Get a big picture grip on the details.”
Chao Kli Ning