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Market Opacity and Fragility: Why Liquidity Evaporates When It Is Most Needed

Author

Listed:
  • Giovanni Cespa
  • Xavier Vives

Abstract

Lack of market transparency can impair the liquidity provision of nonstandard liquidity suppliers and make liquidity demand increasing in illiquidity. This can yield strategic complementarities and induce multiple equilibria. Then an initial dearth of liquidity may degenerate into a liquidity rout (as in a "flash crash"), and traders faced with the largest cost of trading are those trading more intensely at equilibrium. An increase in order flow transparency and/or in the mass of dealers who are in the market at all times has a positive impact on total welfare.

Suggested Citation

  • Giovanni Cespa & Xavier Vives, 2026. "Market Opacity and Fragility: Why Liquidity Evaporates When It Is Most Needed," American Economic Review, American Economic Association, vol. 116(7), pages 2454-2503, July.
    • Handle: RePEc:aea:aecrev:v:116:y:2026:i:7:p:2454-2503
    DOI: 10.1257/aer.20231613
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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