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When Do Trade Frictions Increase Liquidity?

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Abstract

Economists tend to assume that frictions that limit trading in financial markets reduce liquidity and lower investor welfare. In this blog I discuss a recent staff study of mine that challenges that conventional wisdom. I explain how introducing trading frictions—such as circuit breakers—that slow or halt trading in an over-the-counter market experiencing a fire sale might, paradoxically, lead to higher liquidity and investor welfare.

Suggested Citation

  • Gara Afonso, 2011. "When Do Trade Frictions Increase Liquidity?," Liberty Street Economics 20111219, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednls:86780
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    More about this item

    Keywords

    asset pricing; search; congestion; trading halts; Liquidity;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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