Liquidity Crunch and Flight To Liquidity
A phenomenon frequently observed during liquidity crises is Flight to liquidity as investors exit illiquid investments and turn to secondary markets in pursuit of cash–like or easily saleable assets. Empirical evidence points towards widening price differentials, during periods of liquidity shortage, among assets that are otherwise alike, but differ in terms of their asset market liquidity. For instance, there are often large liquidity premia (in some cases as much as 10-15%) in Treasury bond prices. An example of a flight to liquidity occurred during the 1998 Russian financial crisis, when the price of Treasury bonds sharply rose relative to less liquid debt instruments. This resulted in widening of credit spreads and major losses at Long Term Capital Management and many other hedge funds.
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