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Why a Liquidity Crisis Is Heading to a Market Near You

Why a Liquidity Crisis Is Heading to a Market Near You

Trading Secrets

Capital market theory posits that price always balances supply and demand, more or less guaranteeing deep and continuous markets for securities. In other words, if capital markets were a machine, prices would rapidly adjust to reflect any newly disclosed information, and ready buyers and sellers would reveal themselves at the new and improved price levels. But, thankfully for those of us working as active asset managers, markets are anything but mechanistic. They do have a mood, or if you will, a zeitgeist. This is hardly news to anyone involved with real world, as opposed to textbook, investing. Markets always have–and always will–cycle between fear and greed, between rip-snorting bull markets and gut wrenching collapses. Should it really surprise anyone that liquidity waxes and wanes, in sync with the tides of investor emotion?

It should not. Markets do not operate independent of human action–they are the product of, and therefore reflect human decision-making. Liquidity crises should not be understood as bizarre out-of-body experiences: they are built into the very DNA of the market.

The Timeless Time-Varying Information Demands of the Investor

Consider: When times are good and money can be made pretty much effortlessly, investors get careless. Or, maybe a better way to characterize investor behavior is that buyers come to believe that the only mistake they can make is to not invest. But it is also more complicated than that, because investing is a human activity that takes place in a socially constructed context.

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