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Ambiguity aversion, funding liquidity, and liquidation dynamics

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  • Oh, Ji Yeol Jimmy

Abstract

This paper examines how ambiguity aversion and funding liquidity affect market dynamics when a large strategic trader is forced to liquidate. More specifically, the paper explores how ambiguity over an asset's value affects liquidation dynamics when ambiguity-averse traders follow maxmin utility. I also present the joint effects of ambiguity and limited funding liquidity on this liquidation process. The findings reveal that the presence of ambiguity leads to the emergence of a ‘no-trade region.’ This lack of trading activity under ambiguity becomes more prominent as the ambiguous support widens, and interestingly, as the initial wealth of the distressed strategic trader increases.

Suggested Citation

  • Oh, Ji Yeol Jimmy, 2014. "Ambiguity aversion, funding liquidity, and liquidation dynamics," Journal of Financial Markets, Elsevier, vol. 18(C), pages 49-76.
    • Handle: RePEc:eee:finmar:v:18:y:2014:i:c:p:49-76
    DOI: 10.1016/j.finmar.2013.07.003
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    Cited by:

    1. Lien, Donald & Yu, Chia-Feng (Jeffrey), 2017. "Production and hedging with optimism and pessimism under ambiguity," International Review of Economics & Finance, Elsevier, vol. 50(C), pages 122-135.

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    More about this item

    Keywords

    Knightian uncertainty; Forced liquidation; Maxmin utility; Trading freeze; Fire-sale price;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • 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

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