Date Added: Feb 2010
Liquidity, the ease of converting assets to cash, is perhaps one of the most mysterious terms in both finance and macroeconomics. In economic booms the world is abundant with liquidity, but when crisis hits liquidity drains out immediately as if it didn't exist at all. The reason why financial institutions hold liquid - while low yielding - assets, has been extensively explored since (at least as early as) Keynes (1936) - the liquid assets enable agents to better weather shocks in their liabilities. Therefore, when agents face liquidity shortages, they have to sell their illiquid - yet high yielding - assets, at a cost ("Bid-ask spread").