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Liquidity and Financial Market Runs

Author

Listed:
  • Antonio E. Bernardo
  • Ivo Welch

Abstract

We model a run on a financial market, in which each risk-neutral investor fears having to liquidate shares after a run, but before prices can recover back to fundamental values. To avoid having to possibly liquidate shares at the marginal postrun price—in which case the risk-averse market-making sector will already hold a lot of share inventory and thus be more reluctant to absorb additional shares—each investor may prefer selling today at the average in-run price, thereby causing the run itself. Liquidity runs and crises are not caused by liquidity shocks per se, but by the fear of future liquidity shocks.

Suggested Citation

  • Antonio E. Bernardo & Ivo Welch, 2004. "Liquidity and Financial Market Runs," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 119(1), pages 135-158.
    • Handle: RePEc:oup:qjecon:v:119:y:2004:i:1:p:135-158.
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    File URL: http://hdl.handle.net/10.1162/003355304772839542
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