CHAPTER 13Product over Process: Balance Complexity with Liquidity

No, this chapter title is not “Balance Complexity with Liquor.” Instead, this chapter is about liquidity. The central problem for any relative pricing model is its inadequacy given systemic illiquidity because prices in all assets collapse simultaneously—and cash becomes king. Perhaps one shouldn’t distinguish pricing models from valuation models, but at least valuation assumes some notion of fundamentals and aims at determining implied value, dubious as the effort is. Pricing models are relational, and illiquidity in such models can be disastrous.

People sometimes manage illiquidity by getting flat to the market: They take out shorts to cover the long losses. As declines persist, ...

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