Lasse H. Pedersen's research shows that investors need to be compensated for incurring trading costs and the risk of rising trading costs. Therefore, securities with higher market liquidity risk have higher required return, as per the liquidity-adjusted CAPM. Further, many investors face funding constraints (e.g., leverage constraints and margin requirements), and funding liquidity problems affect security prices. Funding constraints raise the required return for securities with high margin requirements or low risk. His research shows how the interaction between market and funding liquidity risk can create
liquidity spirals and liquidity crises. Liquidity problems affect the macro economy and imply that monetary authorities can manage leverage and margin requirements as a second monetary tool. One of the implications of his research on systemic risk is the argument in favour of regulatory authorities implementing systemic risk surcharges to generate incentives for financial institutions to limit their contributions to systemic risk. Under a regime with such surcharges, institutions would aim to lower their surcharges by reducing size, leverage, risk, and correlation with the rest of the financial sector and the economy. ==References==