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Liquidity and Financial Market Runs

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  • Antonio E. Bernardo
  • Ivo Welch

Abstract

We model a run on a financial market, in which each risk-neutral investor fears having to liquidate shares after a run, but before prices can recover back to fundamental values. To avoid having to possibly liquidate shares at the marginal postrun price-in which case the risk-averse market-making sector will already hold a lot of share inventory and thus be more reluctant to absorb additional shares-each investor may prefer selling today at the average in-run price, thereby causing the run itself. Liquidity runs and crises are not caused by liquidity shocks per se, but by the fear of future liquidity shocks. © 2004 the President and Fellows of Harvard College and the Massachusetts Institute of Technology

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Bibliographic Info

Article provided by MIT Press in its journal The Quarterly Journal of Economics.

Volume (Year): 119 (2004)
Issue (Month): 1 (February)
Pages: 135-158

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Handle: RePEc:tpr:qjecon:v:119:y:2004:i:1:p:135-158

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  1. Ray C. Fair, 2002. "Events That Shook the Market," The Journal of Business, University of Chicago Press, vol. 75(4), pages 713-732, October.
  2. Brennan, Michael J & Schwartz, Eduardo S, 1989. "Portfolio Insurance and Financial Market Equilibrium," The Journal of Business, University of Chicago Press, vol. 62(4), pages 455-72, October.
  3. Chowdhry, Bhagwan & Nanda, Vikram, 1998. "Leverage and Market Stability: The Role of Margin Rules and Price Limits," The Journal of Business, University of Chicago Press, vol. 71(2), pages 179-210, April.
  4. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
  5. Basak, Suleyman, 1995. "A General Equilibrium Model of Portfolio Insurance," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 1059-90.
  6. Baumol, William J, 1982. "Contestable Markets: An Uprising in the Theory of Industry Structure," American Economic Review, American Economic Association, vol. 72(1), pages 1-15, March.
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