Circuit Breakers and Market Runs
AbstractThis paper analyzes whether the application of a “circuit breaker” to a financial market (i.e. a mechanism that interrupts trading for a predetermined period when the price moves beyond a predetermined level) reaches its intended goals of increased market stability and overall welfare. Our framework of analysis is a model in which investors can trade at several dates and might face a liquidity shock forcing them to sell immediately when the shock occurs. This setting potentially induces a “market run” where investors commonly sell merely out of fear other investors are selling and not because they have current liquidity needs. We show that the introduction of a sufficiently tightly-set circuit breaker within this setting successfully prevents this market run from occurring. Even more so, it could induce the socially optimal state (in which trading only takes place when it is motivated by liquidity needs) to arise. However, this desirable equilibrium can only be reached under particular economic conditions. When these conditions are not met, installing a circuit breaker might even lower social welfare as compared to a setting without a circuit breaker as it impedes socially desirable trades and stimulates socially undesirable trades.
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 Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 313.
Date of creation: 04 May 2012
Date of revision:
liquidity crisis; market stability; trading halt; high frequency trading; flash crash;
Find related papers by JEL classification:
- D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
- G01 - Financial Economics - - General - - - Financial Crises
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
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.:
- Adrian, Tobias & Shin, Hyun Song, 2010.
"Liquidity and leverage,"
Journal of Financial Intermediation,
Elsevier, vol. 19(3), pages 418-437, July.
- Lasse Heje Pederson & Markus K Brunnermeier, 2007.
"Market Liquidity and Funding Liquidity,"
FMG Discussion Papers
dp580, Financial Markets Group.
- Brunnermeier, Markus K & Pedersen, Lasse Heje, 2007. "Market Liquidity and Funding Liquidity," CEPR Discussion Papers 6179, C.E.P.R. Discussion Papers.
- Markus K. Brunnermeier & Lasse Heje Pedersen, 2007. "Market Liquidity and Funding Liquidity," NBER Working Papers 12939, National Bureau of Economic Research, Inc.
- Subrahmanyam, Avanidhar, 1994. " Circuit Breakers and Market Volatility: A Theoretical Perspective," Journal of Finance, American Finance Association, vol. 49(1), pages 237-54, March.
- Grossman, S.J. & Miller, M.H., 1988.
"Liquidity And Market Structure,"
88, Princeton, Department of Economics - Financial Research Center.
- William G. Christie & Shane A. Corwin & Jeffrey H. Harris, 2002. "Nasdaq Trading Halts: The Impact of Market Mechanisms on Prices, Trading Activity, and Execution Costs," Journal of Finance, American Finance Association, vol. 57(3), pages 1443-1478, 06.
- Allaudeen Hameed & Wenjin Kang & S. Viswanathan, 2010. "Stock Market Declines and Liquidity," Journal of Finance, American Finance Association, vol. 65(1), pages 257-293, 02.
- Pierre-Olivier Weill & Johan Hombert & Bruno Biais, 2012.
"Trading and liquidity with limited cognition,"
2012 Meeting Papers
118, Society for Economic Dynamics.
- Biais, Bruno & Hombert, Johan & Weill, Pierre-Olivier, 2010. "Trading and Liquidity with Limited Cognition," IDEI Working Papers 665, Institut d'Économie Industrielle (IDEI), Toulouse.
- Pierre-Olivier Weill & Johan Hombert & Bruno Biais, 2011. "Trading and Liquidity with Limited Cognition," 2011 Meeting Papers 475, Society for Economic Dynamics.
- Bruno Biais & Johan Hombert & Pierre-Olivier Weill, 2010. "Trading and Liquidity with Limited Cognition," NBER Working Papers 16628, National Bureau of Economic Research, Inc.
- Biais, Bruno & Hombert, Johan & Weill, Pierre-Olivier, 2010. "Trading and Liquidity with Limited Cognition," TSE Working Papers 10-242, Toulouse School of Economics (TSE).
- Lauterbach, Beni & Ben-Zion, Uri, 1993. " Stock Market Crashes and the Performance of Circuit Breakers: Empirical Evidence," Journal of Finance, American Finance Association, vol. 48(5), pages 1909-25, December.
- Gromb, Denis & Vayanos, Dimitri, 2001.
"Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs,"
CEPR Discussion Papers
3049, C.E.P.R. Discussion Papers.
- Gromb, Denis & Vayanos, Dimitri, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 361-407.
- Antonio Bernardo & Ivo Welch, 2006.
"Liquidity and Financial Market Runs,"
Yale School of Management Working Papers
ysm280, Yale School of Management, revised 01 Aug 2003.
- Diamond, Douglas W & Dybvig, Philip H, 1983.
"Bank Runs, Deposit Insurance, and Liquidity,"
Journal of Political Economy,
University of Chicago Press, vol. 91(3), pages 401-19, June.
- Charles S. Morris, 1990. "Coordinating circuit breakers in stock and futures markets," Economic Review, Federal Reserve Bank of Kansas City, issue Mar, pages 35-48.
- Gerety, Mason S & Mulherin, J Harold, 1992. " Trading Halts and Market Activity: An Analysis of Volume at the Open and the Close," Journal of Finance, American Finance Association, vol. 47(5), pages 1765-84, December.
- Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
- Albert J. Menkveld, 2011. "High Frequency Trading and the New-Market Makers," Tinbergen Institute Discussion Papers 11-076/2/DSF21, Tinbergen Institute, revised 15 Aug 2011.
- Greenwood, Robin, 2005. "Short- and long-term demand curves for stocks: theory and evidence on the dynamics of arbitrage," Journal of Financial Economics, Elsevier, vol. 75(3), pages 607-649, March.
- James T. Moser, 1990. "Circuit breakers," Economic Perspectives, Federal Reserve Bank of Chicago, issue Sep, pages 2-13.
- Subrahmanyam, Avanidhar, 1995. "On rules versus discretion in procedures to halt trade," Journal of Economics and Business, Elsevier, vol. 47(1), pages 1-16, February.
- Terrence Hendershott & Charles M. Jones & Albert J. Menkveld, 2011. "Does Algorithmic Trading Improve Liquidity?," Journal of Finance, American Finance Association, vol. 66(1), pages 1-33, 02.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Lia Ambrosio).
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.