We study the dynamics of liquidity provision by dealers during an asset market crash, described as a temporary negative shock to investors aggregate asset demand. We consider a class of dynamic market settings where dealers can trade continuously with each other, while trading between dealers and investors is subject to delays and involves bargaining. We derive conditions on fundamentals, such as preferences, market structure and the characteristics of the market crash (e.g., severity, persistence) under which dealers provide liquidity to investors following the crash. We also characterize the conditions under which dealers incentives to provide liquidity are consistent with market efficiency.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
14119.
Length: Date of creation: Jun 2008 Date of revision: Handle: RePEc:nbr:nberwo:14119
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Find related papers by JEL classification: C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy G1 - Financial Economics - - General Financial Markets
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Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2004.
"Over-the-Counter Markets,"
NBER Working Papers
10816, National Bureau of Economic Research, Inc.
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Grossman, S.J. & Miller, M.H., 1988.
"Liquidity And Market Structure,"
Papers
88, Princeton, Department of Economics - Financial Research Center.
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Ricardo Lagos & Guillaume Rocheteau, 2006.
"Search in asset markets,"
Staff Report
375, Federal Reserve Bank of Minneapolis.
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