Market distress and vanishing liquidity: anatomy and policy options
AbstractSince the 1980s, a number of episodes of financial market distress have underscored the importance of the smooth functioning of markets for the stability of the financial system. At the heart of these episodes was a sudden and drastic reduction in market liquidity, characterised by disorderly adjustments in asset prices, a sharp increase in the costs of executing transactions and, in the most acute cases, a "seizing up" of markets. This essay explores the anatomy of market distress as well as the policy options to address it. It argues that, despite appearances, the genesis and dynamics of market distress resemble quite closely those of banking distress and that, contrary to conventional wisdom, the growth of markets for tradable instruments, and hence the greater scope to sell assets and raise cash, need not have reduced the likelihood of funding (liquidity) crises. At times of distress, in contrast to more normal times, risk management practices, funding constraints and counterparty risk become critical determinants of market liquidity. Articulating an appropriate policy response calls for an approach that takes full account of the interdependencies between the behaviour of market participants and market dynamics. To date, much useful work has been done to address market distress by improving the market infrastructure and the risk management at individual financial institutions. The territory that remains largely unexplored is precisely the link between the collective actions of individual market participants and market dynamics.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Bank for International Settlements in its series BIS Working Papers with number 158.
Length: 35 pages
Date of creation: Jul 2004
Date of revision:
Market distress and vanishing liquidity: anatomy and policy options;
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- repec:ebl:ecbull:v:28:y:2003:i:6:p:a6 is not listed on IDEAS
- Miroslav Misina, 2003.
"What Does the Risk-Appetite Index Measure?,"
Working Papers, Bank of Canada
03-23, Bank of Canada.
- T. Todd Smith & Garry J. Schinasi, 1999.
"Portfolio Diversification, Leverage, and Financial Contagion,"
IMF Working Papers
99/136, International Monetary Fund.
- Garry J. Schinasi & R. Todd Smith, 2000. "Portfolio Diversification, Leverage, and Financial Contagion," IMF Staff Papers, Palgrave Macmillan, vol. 47(2), pages 1.
- Christian Upper, 2001.
"How safe was the "Safe Haven"? Financial market liquidity during the 1998 turbulences,"
BIS Papers chapters,
in: Bank for International Settlements (ed.), Market liquidity: proceedings of a workshop held at the BIS, volume 2, pages 241-266
Bank for International Settlements.
- Upper, Christian, 2000. "How safe was the "safe haven"? Financial market liquidity during the 1998 turbulences," Discussion Paper Series 1: Economic Studies 2000,01, Deutsche Bundesbank, Research Centre.
- Campbell, John Y & Grossman, Sanford J & Wang, Jiang, 1993.
"Trading Volume and Serial Correlation in Stock Returns,"
The Quarterly Journal of Economics, MIT Press,
MIT Press, vol. 108(4), pages 905-39, November.
- John Y. Campbell & Sanford J. Grossman & Jiang Wang, 1992. "Trading Volume and Serial Correlation in Stock Returns," NBER Working Papers 4193, National Bureau of Economic Research, Inc.
- Wang, Jiang & Grossman, Sanford & Campbell, John, 1993. "Trading Volume and Serial Correlation in Stock Returns," Scholarly Articles 3128710, Harvard University Department of Economics.
- Helmut Elsinger & Alfred Lehar & Martin Summer, 2006.
"Risk Assessment for Banking Systems,"
Management Science, INFORMS,
INFORMS, vol. 52(9), pages 1301-1314, September.
- Helmut Elsinger & Alfred Lehar & Martin Summer, 2002. "Risk Assessment for Banking Systems," Working Papers, Oesterreichische Nationalbank (Austrian Central Bank) 79, Oesterreichische Nationalbank (Austrian Central Bank).
- Danielsson, Jon & Shin, Hyun Song & Zigrand, Jean-Pierre, 2004. "The impact of risk regulation on price dynamics," Journal of Banking & Finance, Elsevier, Elsevier, vol. 28(5), pages 1069-1087, May.
- Michael J. Fleming, 2001. "Financial market implications of the federal debt paydown," Staff Reports, Federal Reserve Bank of New York 120, Federal Reserve Bank of New York.
- Michael J. Fleming & Eli M. Remolona, 1999. "Price Formation and Liquidity in the U.S. Treasury Market: The Response to Public Information," Journal of Finance, American Finance Association, American Finance Association, vol. 54(5), pages 1901-1915, October.
- Prasanna Gai & Sujit Kapadia & Stephen Millard & Ander Perez, 2008.
"Financial Innovation, Macroeconomic Stability and Systemic Crises,"
Economic Journal, Royal Economic Society,
Royal Economic Society, vol. 118(527), pages 401-426, 03.
- Prasanna Gai & Sujit Kapadia & Stephen Millard & Ander Perez, 2006. "Financial innovation, macroeconomic stability and systemic crises," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Nov.
- Prasanna Gai & Sujit Kapadia & Stephen Millard & Ander Perez, 2008. "Financial innovation, macroeconomic stability and systemic crises," Bank of England working papers, Bank of England 340, Bank of England.
- Ilhyock Shim & Goetz von Peter, 2007. "Distress selling and asset market feedback," BIS Working Papers 229, Bank for International Settlements.
- Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2008.
"Crashes and Recoveries in Illiquid Markets,"
NBER Working Papers
14119, National Bureau of Economic Research, Inc.
- Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2007. "Crashes and recoveries in illiquid markets," Working Paper 0708, Federal Reserve Bank of Cleveland.
- Pierre-Olivier Weill & Guillaume Rocheteau & Ricardo Lagos, 2007. "Crashes and Recoveries in Illiquid Markets," 2007 Meeting Papers, Society for Economic Dynamics 981, Society for Economic Dynamics.
- Bezemer, Dirk J., 2010. "Understanding financial crisis through accounting models," Accounting, Organizations and Society, Elsevier, vol. 35(7), pages 676-688, October.
- Dirk J. Bezemer, 2012. "Modelos contables y comprensión de la crisis financiera," Revista de Economía Institucional, Universidad Externado de Colombia - Facultad de Economía, Universidad Externado de Colombia - Facultad de Economía, vol. 14(26), pages 47-76, January-J.
- Robert R. Bliss & George Kaufman, 2005. "Derivatives and systemic risk: netting, collateral, and closeout," Working Paper Series, Federal Reserve Bank of Chicago WP-05-03, Federal Reserve Bank of Chicago.
- Borio, Claudio & Tsatsaronis, Kostas, 2004. "Accounting and prudential regulation: from uncomfortable bedfellows to perfect partners?," Journal of Financial Stability, Elsevier, Elsevier, vol. 1(1), pages 111-135, September.
- Michele Caivano & Lisa Rodano & Stefano Siviero, 2010. "The transmission of the global financial crisis to the Italian economy. A counterfactual analysis, 2008-2010," Questioni di Economia e Finanza (Occasional Papers) 64, Bank of Italy, Economic Research and International Relations Area.
- Wang, Jianxin, 2013. "Liquidity commonality among Asian equity markets," Pacific-Basin Finance Journal, Elsevier, Elsevier, vol. 21(1), pages 1209-1231.
- Bliss, Robert R. & Kaufman, George G., 2006. "Derivatives and systemic risk: Netting, collateral, and closeout," Journal of Financial Stability, Elsevier, Elsevier, vol. 2(1), pages 55-70, April.
- Helena, BELTRAN & Alain, DURRE & Pierre, GIOT, 2004.
"Volatility regimes and the provisions of liquidity in order book markets,"
Discussion Papers (ECON - DÃ©partement des Sciences Economiques), UniversitÃ© catholique de Louvain, DÃ©partement des Sciences Economiques
2005015, Université catholique de Louvain, Département des Sciences Economiques.
- BELTRAN, Helena & DURRE, Alain & GIOT, Pierre, 2005. "Volatility regimes and the provision of liquidity in order book markets," CORE Discussion Papers, UniversitÃ© catholique de Louvain, Center for Operations Research and Econometrics (CORE) 2005012, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Timo Laurmaa).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.