Liquidity and Valuation in an Uncertain World
- 1 September 2008
- preprint
- Published by Elsevier in SSRN Electronic Journal
Abstract
In the current credit crisis there is little or no trade in a variety of financial assets, even though bids and asks exist for many of these assets. We develop a model in which this illiquidity arises from uncertainty, and we argue that this new form of illiquidity makes bid and ask prices unsuitable as metrics for establishing fair value for these assets. We show how the extreme uncertainty that traders currently face can be characterized by incomplete preferences over portfolios, and we use Bewley's [2002] model of decision making under uncertainty to derive equilibrium quotes and the non-existence of trade at these quotes. Having established the origin of the quotes, and why the market freezes, we are then able to use our approach to suggest alternatives for valuing assets in illiquid markets.Keywords
This publication has 30 references indexed in Scilit:
- Risk, uncertainty, and asset pricesPublished by Elsevier ,2008
- Collective Risk Management in a Flight to Quality EpisodePublished by National Bureau of Economic Research ,2007
- Feedback loops, fair value accounting and correlated investmentsReview of Accounting Studies, 2006
- Information, trade and incomplete marketsEconomic Theory, 2005
- Model Uncertainty, Limited Market Participation, and Asset PricesThe Review of Financial Studies, 2005
- Knightian decision theory. Part IDecisions in Economics and Finance, 2002
- A Survey of Behavioral FinancePublished by National Bureau of Economic Research ,2002
- Ambiguity, Risk, and Asset Returns in Continuous TimeEconometrica, 2002
- The Market for "Lemons": Quality Uncertainty and the Market MechanismThe Quarterly Journal of Economics, 1970
- Utility Theory without the Completeness AxiomEconometrica, 1962