A flight-to-liquidity is a financial market phenomenon occurring when investors sell what they perceive to be less
liquid
Liquid is a state of matter with a definite volume but no fixed shape. Liquids adapt to the shape of their container and are nearly incompressible, maintaining their volume even under pressure. The density of a liquid is usually close to th ...
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 environ ...
investments, and purchase more liquid investments instead, such as
US Treasuries. Usually, flight-to-liquidity quickly results in panic leading to a crisis.
For example, after the
Russia
Russia, or the Russian Federation, is a country spanning Eastern Europe and North Asia. It is the list of countries and dependencies by area, largest country in the world, and extends across Time in Russia, eleven time zones, sharing Borders ...
n government
defaulted on its
government bond
A government bond or sovereign bond is a form of Bond (finance), bond issued by a government to support government spending, public spending. It generally includes a commitment to pay periodic interest, called Coupon (finance), coupon payments' ...
s (
GKOs) in 1998 many investors sold European and Japanese
government bond
A government bond or sovereign bond is a form of Bond (finance), bond issued by a government to support government spending, public spending. It generally includes a commitment to pay periodic interest, called Coupon (finance), coupon payments' ...
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known as “on-the-run”, have larger trading volumes, that is more liquidity, than treasury issues that have been superseded, known as “off-the run”.)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 hedge fund.
LTCM case study
See also
* Financial contagion
* 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 Bank run#Systemic banki ...
* 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 as an investment, gold and Government bond, gover ...
* Stock market crash
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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