That liquidity premium then has to lead to quick flush out of the shadow inventory.
They should be earning a super-duper liquidity premium and that is essentially my core definition of a bubble.
The liquidity premium is a dead weight loss to the economy in that it is a discouragement to investment.
Its called a liquidity premium and its variance over time drives both difference in volatility and average return between investment vehicles.
Such a model which ignores the liquidity premium, when compared to subsequent history, seems to have a bias towards overstating inflation.
In this sense the liquidity premium, like the inflation premium, is another interest rate distorter, and therefore another masker of the truth.
Even given those factors, the liquidity premium versus bonds is still enormous.
Nonetheless, there is currently an enormous liquidity premium attached to housing.
The market prices of many mortgage securities today reflect not just the likelihood of default, but a steep liquidity premium, because the paper no longer trades.
However, I do suspect that there is a liquidity an extra liquidity premium being priced into Treasuries and that this is what I would call a bubble.
And the reason for that is very simple: Public companies are always willing to pay more for a stock than a private investor would, because of something called the liquidity premium.
All of that raises the relative liquidity premium of the US Treasuries and of any nation or indeed any organization that has a Lender of Last Resort with access to unlimited liquidity, that is a printing press.
In part, the premium reflects the inferior liquidity of second-lien paper.
That an investor can earn a large premium by using his capital to supply liquidity should, through market forces, ensure there is enough liquidity available.
Lots of theories have been produced to explain this puzzle, but the most plausible answer may be that the premium varies according to the circumstances and the markets' liquidity which is pretty useless if you are trying to make predictions.
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