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The evidence presented in this paper suggests that asset-side shock affecting the funding available to financial intermediaries contributes to significant time-variation in liquidity. Consistent with recent theoretical models where binding capital constraints lead to sudden liquidity dry-ups, it finds that negative market returns decrease stock liquidity, especially for high volatility stocks and during times of tightness in the funding market. The asymmetric effect of changes in aggregate asset values on liquidity and commonality in liquidity cannot be fully explained by changes in demand for liquidity or volatility effects. This paper also finds economically significant returns to supplying liquidity following periods of large drop in market valuations.
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