A flight-to-liquidity is a financial market phenomenon occurring when investors sell what they perceive to be less
liquid
A liquid is a nearly incompressible fluid that conforms to the shape of its container but retains a (nearly) constant volume independent of pressure. As such, it is one of the four fundamental states of matter (the others being solid, gas, a ...
or higher
risk
In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environme ...
investments, and purchase more liquid investments instead, such as
US Treasuries
United States Treasury securities, also called Treasuries or Treasurys, are government debt instruments issued by the United States Department of the Treasury to finance government spending as an alternative to taxation. Since 2012, U.S. gov ...
. Usually, flight-to-liquidity quickly results in panic leading to a crisis.
For example, after the
Russia
Russia (, , ), or the Russian Federation, is a List of transcontinental countries, transcontinental country spanning Eastern Europe and North Asia, Northern Asia. It is the List of countries and dependencies by area, largest country in the ...
n government
defaulted on its
government bond
A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments'','' and to repay the face value on the maturity date ...
s (
GKO
GKO (abbreviation for russian: Государственное Краткосрочное Обязательство, Gosudarstvennoye Kratkosrochnoye Obyazatyelstvo, Government Short-Term Commitments) are short-term zero-coupon government bonds i ...
s) in 1998 many investors sold European and Japanese
government bond
A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments'','' and to repay the face value on the maturity date ...
s and purchased on-the-run US Treasuries instead.
(The most recently issued treasuries, known as “on-the-run”, have larger trading volumes, that is more liquidity, than treasury issues that have been superseded, known as “off-the run”.)
This widened the spread between off-the-run and on-the-run US Treasuries, which ultimately led to the 1998 collapse of the
Long-Term Capital Management
Long-Term Capital Management L.P. (LTCM) was a highly-leveraged hedge fund. In 1998, it received a $3.6 billion bailout from a group of 14 banks, in a deal brokered and put together by the Federal Reserve Bank of New York.
LTCM was founded in 1 ...
hedge fund.
LTCM case study
See also
* Financial contagion
Financial contagion refers to "the spread of market disturbances mostly on the downside from one country to the other, a process observed through co-movements in exchange rates, stock prices, sovereign spreads, and capital flows". Financial contag ...
* Financial crisis
A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and man ...
* Flight-to-quality
A flight-to-quality, or flight-to-safety, is a financial market phenomenon occurring when investors sell what they perceive to be higher-risk investments and purchase safer investments, such as gold and other precious metals. This is considered a s ...
* Stock market crash
A stock market crash is a sudden dramatic decline of stock
In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especia ...
References
External links
The Flight-to-Liquidity Premium in U.S. Treasury Bond Prices
Flight to Liquidity Due to Heterogeneity in Investment Horizon
Financial problems
Financial markets
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