Answers are grounded in this paper and cite their sources.
Liquidity providers often learn information about an asset from prices of other assets. We show that this generates a self-reinforcing positive relationship between price informativeness and liquidity. This relationship causes liquidity spillovers and is a source of fragility: a small drop in the liquidity of one asset can, through a feedback loop, result in a very large drop in market liquidity and price informativeness (a liquidity crash). This feedback loop provides a new explanation for comovements in liquidity and liquidity dry-ups. It also generates multiple equilibria.
No takes yet. Share an insight, caveat, or question.
Cespa et al. (2014) studied this question.
Synapse has enriched 10 related papers. Consider them for comparative context: