1.5 The Structure of This Book
This book sets out to explain and discuss the questions and puzzles we just presented, using liquidity risk as a primary explanatory variable.
After this introductory chapter to liquidity, Chapter 2, "Liquidity Risk: Concepts," will define the key concepts surrounding the concept, such as liquidity cost, liquidity risk, and liquidity risk premium. We explore how financial institutions bear liquidity risk in their balance sheets. And we end the chapter with a discussion on how that affects financial institutions, especially banks, and the subsequent effects this has on the global economy.
In the three following chapters, we analyze three major historical liquidity shocks that occurred during the twentieth century. (There are many other examples during this time period, but we picked three of the most prominent ones.) We trace the shocks as they affect financial institutions and, subsequently, spread to the nonfinancial sector. In Chapter 3 we look at the United States Great Depression (1929-1933); in Chapter 4, we study Japan's Lost Decade of the 1990s; and in Chapter 5 we look at the United States Great Recession (2007-2009).
The book's final chapter, Chapter 6, explores the question of whether there are ways to lessen the effects of liqudity shocks, perhaps through public policy.
The book is written assuming that the reader has some familiarity with finance and economics. Concepts such as supply/demand equilibrium, bond yields, and option payoffs hopefully are not new.
Now, let's dive into the pool of liquidity risk.