Flight-to-Liquidity
Encyclopedia
A flight-to-liquidity is a financial market phenomenon occurring when investors sell what they perceive to be less liquid or higher risk
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
n government defaulted on its government bond
s (GKO
s) in 1998 many investors sold European and Japanese government bond
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known as “on-the-run”, have larger trading volumes, that is more liquidity, than treasury issues that have been superseded, known as “off-the run”.)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.
Risk
Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...
investments, and purchase more liquid investments instead, such as US Treasuries
Treasury security
A United States Treasury security is government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States federal government, and they are often referred to simply as Treasuries...
. Usually, flight-to-liquidity quickly results in panic leading to a crisis.
For example, after the Russia
Russia
Russia or , officially known as both Russia and the Russian Federation , is a country in northern Eurasia. It is a federal semi-presidential republic, comprising 83 federal subjects...
n government defaulted on its government bond
Government bond
A government bond is a bond issued by a national government denominated in the country's own currency. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country...
s (GKO
GKO
GKO , OFZ are abbreviations for and , respectively. They are government bonds issued by the state of Russia.GKOs are short-term zero-coupon Russian Government Treasury Bills. OFZs are coupon-bearing Federal Loan Bonds...
s) in 1998 many investors sold European and Japanese government bond
Government bond
A government bond is a bond issued by a national government denominated in the country's own currency. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country...
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
Long-Term Capital Management L.P. was a speculative hedge fund based in Greenwich, Connecticut that utilized absolute-return trading strategies combined with high leverage...
hedge fund.
See also
- Financial contagionFinancial contagionFinancial contagion refers to a scenario in which small shocks, which initially affect only a few financial institutions or a particular region of an economy, spread to the rest of financial sectors and other countries whose economies were previously healthy, in a manner similar to the transmission...
- Financial crisisFinancial crisisThe term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these...
- Flight-to-qualityFlight-to-qualityA flight-to-quality is a financial market phenomenon occurring when investors sell what they perceive to be higher-risk investments and purchase safer investments, such as US Treasuries or gold...
- Safe havenSafe havenSafe haven may refer to:* Safe harbor, a harbor or haven which provides safety from weather or attack, or an analogous situation* Safe Havens, a syndicated comic strip drawn by cartoonist Bill Holbrook...
- Stock market crashStock market crashA stock market crash is a sudden dramatic decline of stock prices across a significant cross-section of a stock market, resulting in a significant loss of paper wealth. Crashes are driven by panic as much as by underlying economic factors...