Liquidity Preference And Information

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Executive Summary

This paper explores the link between anticipated information and a preference for liquidity in investment choices. Given a subjective ordering of investment portfolios by their liquidity, the authors identify a sufficient condition under which the prospect of finer resolution of uncertainty creates a preference for more liquid positions. They then show how this condition might arise naturally in some standard classes of sequential decision problems. The recent financial crisis has, once again, drawn attention to the issue of liquidity. Illiquidity reflects frictions in markets, which tend to be glossed over in periods of ostensible prosperity, but less so in times of economic distress.

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