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This paper explores the spillover effect on asset liquidity in a market populated with traders who agree to disagree during uncertain times. After experiencing a common down shock, heterogeneous traders become uncertain about future asset values, asset prices deviate from equilibrium and form large spreads. The findings seem to suggest (i) given enough ambiguity about the expected value of an asset, the asset becomes illiquid forming a spread; while spilling illiquidity to a correlated asset, creating a correlated spread. The magnitude of the related spread however depends on the degree of correlation. (ii) Since for large ambiguity, no-trade is observed, there must be under some conditions a threshold to trade. It turns out, the threshold to trade depends on the level of common shock and the diversity of beliefs, but is independent of the correlation. Finally, (iii) a reduction in spread is generally observed in an asset that is directly impacted by heterogeneity. However, the spillover of heterogeneity does not always help to reduce the correlated spread. |
