Asset Safety versus Asset Liquidity; Athanasios Geromichalos (University of California, Davis)

Many economists take as given that safer assets will be more liquid, and some have practically used “safe” and “liquid” as synonyms. But these terms are not synonyms, and mixing them up can lead to confusion and wrong policy recommendations. We build a multi-asset model where an asset’s safety and liquidity are well-defined and distinct, and examine their relationship in general equilibrium. We show that the common belief that “safety implies liquidity” is generally justified, but also identify conditions under which this relationship can be reversed. We then use our model to rationalize several safety-liquidity reversals observed in the data.

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