We propose an information-based theory to explain time variation in liquidity and link it to a variety of patterns in asset markets. In "normal times," the market is fully liquid and gains from trade are realized immediately. However, the equilibrium also involves periods during which liquidity...

We estimate a continuous-time model with dynamic crash probability using the S&P500 index options and high-frequency information. We find that market illiquidity is an important factor in explaining the time-varying stock market crash risk embedded in index options. While market illiquidity and...