Our paper oers a minimalist model of a run on a financial market. The prime ingredient is that each risk-neutral investor fears having to liquidate after a run, but before prices can recover back to fundamental values. During the run, only the risk-averse market-making sector is willing to absorb shares. To avoid having to possibly liquidate shares at the marginal post-run pricein which case the market-making sector will already hold a lot of share inventory and thus be more reluctant to absorb additional sharesall investors may prefer selling their shares into the market today at the average run price, thereby causing the run itself. Consequently, stock prices are low and risk is allocated ineciently. Liquidity runs and crises are not caused by liquidity shocks per se, but by the fear of future liquidity shocks.
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Paper
Antonio E. Bernardo & Ivo Welch, 2002.
"Financial Market Runs,"
NBER Working Papers
9251, National Bureau of Economic Research, Inc.
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References listed on IDEAS 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.:
Dilip Abreu & Markus K. Brunnermeier, 2003.
"Bubbles and Crashes,"
Econometrica,
Econometric Society, vol. 71(1), pages 173-204, January.
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De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990.
"Noise Trader Risk in Financial Markets,"
Journal of Political Economy,
University of Chicago Press, vol. 98(4), pages 703-38, August.
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Other versions:
Dow, James & Gorton, Gary, 1994.
" Arbitrage Chains,"
Journal of Finance,
American Finance Association, vol. 49(3), pages 819-49, July.
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Other versions:
James Dow & Gary Gorton, 1993.
"Arbitrage Chains,"
NBER Working Papers
4314, National Bureau of Economic Research, Inc.
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James Dow & Gary Gorton, 1993.
"Arbitrage Chains,"
CEPR Financial Markets Paper
0035, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 53--56 Great Sutton Street, London EC1V 0DG.
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