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In this stimulating new book, the authors bridge the gap between academic and practical experience by advancing the liquidity theory of asset prices. For many investment managers, liquidity is a crucial subject to which academics have paid too little attention. The book demonstrates that knowledge of liquidity is vital for understanding markets. For academics who have not been thoroughly exposed to working in financial markets, the liquidity theory of asset prices will add to the explanatory power of Efficient Markets Hypothesis.
The liquidity theory of prices explains that an investment transaction often takes place because someone either has cash to invest or needs to raise cash. In the economy as a whole the difference between the amount of cash waiting to be invested and the need to raise cash can be substantial; moreover, an imbalance can persist for many months. Markets react accordingly, going up or down as the case may be. When a market is rising, people become optimistic, and pessimistic when a market is falling. If a trend continues investors start acting in a crowd. Crowd psychology becomes important. Booms and busts follow.
An understanding of these forces is important not only for investors but also for industrialist and governments. This book is the only practical explanation of the liquidity theory of asset prices currently available and is guaranteed to go a long way to remedying an embarrassing lack of understanding of an economic force which has moved to centre stage of financial market understanding.