IDEAS home Printed from https://ideas.repec.org/a/oup/rfinst/v27y2014i6p1615-1660..html
   My bibliography  Save this article

Illiquidity Contagion and Liquidity Crashes

Author

Listed:
  • Giovanni Cespa
  • Thierry Foucault

Abstract

Liquidity providers often learn information about an asset from prices of other assets. We show that this generates a self-reinforcing positive relationship between price informativeness and liquidity. This relationship causes liquidity spillovers and is a source of fragility: a small drop in the liquidity of one asset can, through a feedback loop, result in a very large drop in market liquidity and price informativeness (a liquidity crash). This feedback loop provides a new explanation for comovements in liquidity and liquidity dry-ups. It also generates multiple equilibria.

Suggested Citation

  • Giovanni Cespa & Thierry Foucault, 2014. "Illiquidity Contagion and Liquidity Crashes," Review of Financial Studies, Society for Financial Studies, vol. 27(6), pages 1615-1660.
  • Handle: RePEc:oup:rfinst:v:27:y:2014:i:6:p:1615-1660.
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1093/rfs/hhu016
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Neumark, David & Postlewaite, Andrew, 1998. "Relative income concerns and the rise in married women's employment," Journal of Public Economics, Elsevier, pages 157-183.
    2. Peter Kooreman & Adriaan R. Soetevent, 2007. "A discrete-choice model with social interactions: with an application to high school teen behavior," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(3), pages 599-624.
    3. Steven N. Durlauf & Yannis M. Ioannides, 2010. "Social Interactions," Annual Review of Economics, Annual Reviews, vol. 2(1), pages 451-478, September.
    4. Abel Andrew B. & Mailath George J., 1994. "Financing Losers in Competitive Markets," Journal of Financial Intermediation, Elsevier, pages 139-165.
    5. Arie Kapteyn & Rob Alessie & Annamaria Lusardi, 1999. "Explaining the Wealth Holdings of Different Cohorts: Productivity Growth and Social Security," Tinbergen Institute Discussion Papers 99-069/3, Tinbergen Institute.
    6. Woittiez, Isolde & Kapteyn, Arie, 1998. "Social interactions and habit formation in a model of female labour supply," Journal of Public Economics, Elsevier, pages 185-205.
    7. Lundborg, Petter, 2006. "Having the wrong friends? Peer effects in adolescent substance use," Journal of Health Economics, Elsevier, vol. 25(2), pages 214-233, March.
    8. Kapteyn, Arie & Alessie, Rob & Lusardi, Annamaria, 2005. "Explaining the wealth holdings of different cohorts: Productivity growth and Social Security," European Economic Review, Elsevier, pages 1361-1391.
    9. Claudia Senik, 2008. "Ambition and Jealousy: Income Interactions in the 'Old' Europe versus the 'New' Europe and the United States," Economica, London School of Economics and Political Science, vol. 75(299), pages 495-513, August.
    10. Charles F. Manski, 1993. "Identification of Endogenous Social Effects: The Reflection Problem," Review of Economic Studies, Oxford University Press, vol. 60(3), pages 531-542.
    11. Blume, Lawrence E. & Brock, William A. & Durlauf, Steven N. & Ioannides, Yannis M., 2010. "Identification of Social Interactions," Economics Series 260, Institute for Advanced Studies.
    12. Albert O. Hirschman & Michael Rothschild, 1973. "The Changing Tolerance for Income Inequality in the Course of Economic DevelopmentWith A Mathematical Appendix," The Quarterly Journal of Economics, Oxford University Press, vol. 87(4), pages 544-566.
    13. Michael, Haliassos & Dimitris, Christelis & Dimitris, Georgarakos, 2010. "Differences in Portfolios across Countries: Economic Environment versus Household Characteristics," MEA discussion paper series 10204, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.
    14. Adriaan R. Soetevent, 2006. "Empirics of the Identification of Social Interactions; An Evaluation of the Approaches and Their Results ," Journal of Economic Surveys, Wiley Blackwell, vol. 20(2), pages 193-228, April.
    15. Train,Kenneth E., 2009. "Discrete Choice Methods with Simulation," Cambridge Books, Cambridge University Press, number 9780521766555, November.
    16. Peter Kuhn & Peter Kooreman & Adriaan Soetevent & Arie Kapteyn, 2011. "The Effects of Lottery Prizes on Winners and Their Neighbors: Evidence from the Dutch Postcode Lottery," American Economic Review, American Economic Association, pages 2226-2247.
    17. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
    18. Dimitris Christelis & Dimitris Georgarakos & Michael Haliassos, 2013. "Differences in Portfolios across Countries: Economic Environment versus Household Characteristics," The Review of Economics and Statistics, MIT Press, pages 220-236.
    19. Clark, Andrew E. & Oswald, Andrew J., 1996. "Satisfaction and comparison income," Journal of Public Economics, Elsevier, pages 359-381.
    20. Clark, Andrew E. & Oswald, Andrew J., 1994. "Satisfaction and comparison income," CEPREMAP Working Papers (Couverture Orange) 9408, CEPREMAP.
    21. Nikolai Roussanov, 2010. "Diversification and Its Discontents: Idiosyncratic and Entrepreneurial Risk in the Quest for Social Status," Journal of Finance, American Finance Association, vol. 65(5), pages 1755-1788, October.
    22. Harrison Hong & Jeffrey D. Kubik & Jeremy C. Stein, 2004. "Social Interaction and Stock-Market Participation," Journal of Finance, American Finance Association, vol. 59(1), pages 137-163, February.
    23. Hirschman, Albert O., 1973. "The changing tolerance for income inequality in the course of economic development," World Development, Elsevier, vol. 1(12), pages 29-36, December.
    24. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
    25. Jeffrey R. Brown & Zoran Ivkovic & Paul A. Smith & Scott Weisbenner, 2008. "Neighbors Matter: Causal Community Effects and Stock Market Participation," Journal of Finance, American Finance Association, vol. 63(3), pages 1509-1531, June.
    26. Senik, Claudia, 2004. "When information dominates comparison: Learning from Russian subjective panel data," Journal of Public Economics, Elsevier, pages 2099-2123.
    27. Atif Mian & Amir Sufi, 2009. "The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis," The Quarterly Journal of Economics, Oxford University Press, vol. 124(4), pages 1449-1496.
    28. Alvarez-Cuadrado, Francisco & Van Long, Ngo, 2011. "The relative income hypothesis," Journal of Economic Dynamics and Control, Elsevier, pages 1489-1501.
    29. Kaustia, Markku & Knüpfer, Samuli, 2012. "Peer performance and stock market entry," Journal of Financial Economics, Elsevier, vol. 104(2), pages 321-338.
    30. Dimitris Georgarakos & Giacomo Pasini, 2011. "Trust, Sociability, and Stock Market Participation," Review of Finance, European Finance Association, vol. 15(4), pages 693-725.
    31. Gali, Jordi, 1994. "Keeping Up with the Joneses: Consumption Externalities, Portfolio Choice, and Asset Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(1), pages 1-8, February.
    32. Duflo, Esther & Saez, Emmanuel, 2002. "Participation and investment decisions in a retirement plan: the influence of colleagues' choices," Journal of Public Economics, Elsevier, pages 121-148.
    33. Andrew Caplin & John Leahy, 2001. "Psychological Expected Utility Theory and Anticipatory Feelings," The Quarterly Journal of Economics, Oxford University Press, vol. 116(1), pages 55-79.
    34. Clark, Andrew E & Oswald, Andrew J, 1993. "Satisfaction and Comparison Income," Economics Discussion Papers 10018, University of Essex, Department of Economics.
    35. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, pages 38-42.
    36. William A. Brock & Steven N. Durlauf, 2010. "Adoption Curves and Social Interactions," Journal of the European Economic Association, MIT Press, vol. 8(1), pages 232-251, March.
    37. De Giorgi, Giacomo & Frederiksen, Anders & Pistaferri, Luigi, 2016. "Consumption Network Effects," IZA Discussion Papers 9983, Institute for the Study of Labor (IZA).
    38. Neumark, David & Postlewaite, Andrew, 1998. "Relative income concerns and the rise in married women's employment," Journal of Public Economics, Elsevier, pages 157-183.
    39. Blume, Lawrence E. & Brock, William A. & Durlauf, Steven N. & Ioannides, Yannis M., 2010. "Identification of Social Interactions," Economics Series 260, Institute for Advanced Studies.
    40. Alain Cohn & Ernst Fehr & Benedikt Herrmann & Frédéric Schneider, 2011. "Social comparison in the workplace: evidence from a field experiment," ECON - Working Papers 007, Department of Economics - University of Zurich.
    41. Harald Uhlig & Lars Ljungqvist, 2000. "Tax Policy and Aggregate Demand Management under Catching Up with the Joneses," American Economic Review, American Economic Association, pages 356-366.
    42. Liu, Wen-Fang & Turnovsky, Stephen J., 2005. "Consumption externalities, production externalities, and long-run macroeconomic efficiency," Journal of Public Economics, Elsevier, pages 1097-1129.
    43. Rivers, Douglas & Vuong, Quang H., 1988. "Limited information estimators and exogeneity tests for simultaneous probit models," Journal of Econometrics, Elsevier, vol. 39(3), pages 347-366, November.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Itzhak Ben-David & Francesco A. Franzoni & Rabih Moussawi, 2016. "Exchange Traded Funds (ETFs)," Swiss Finance Institute Research Paper Series 16-64, Swiss Finance Institute.
    2. Giovanni Cespa & Xavier Vives, 2016. "High Frequency Trading and Fragility," CESifo Working Paper Series 6279, CESifo Group Munich.
    3. Petrescu, Monica & Wedow, Michael, 2017. "Dark pools in European equity markets: emergence, competition and implications," Occasional Paper Series 193, European Central Bank.
    4. Bank for International Settlements, 2016. "Regulatory change and monetary policy," CGFS Papers, Bank for International Settlements, number 55.
    5. Lescourret, Laurence & Moinas, Sophie, 2014. "Liquidity Supply across Multiple Trading Venues," TSE Working Papers 14-533, Toulouse School of Economics (TSE), revised Mar 2015.
    6. Nina Karnaukh & Angelo Ranaldo & Paul Söderlind, 2015. "Understanding FX Liquidity," Review of Financial Studies, Society for Financial Studies, pages 3073-3108.
    7. Broman, Markus S., 2016. "Liquidity, style investing and excess comovement of exchange-traded fund returns," Journal of Financial Markets, Elsevier, vol. 30(C), pages 27-53.
    8. Nina Karnaukh & Angelo Ranaldo & Paul Söderlind, 2015. "Understanding FX Liquidity," Review of Financial Studies, Society for Financial Studies, pages 3073-3108.
    9. Isaenko, Sergey, 2015. "Equilibrium theory of stock market crashes," Journal of Economic Dynamics and Control, Elsevier, vol. 60(C), pages 73-94.
    10. Isshaq, Zangina & Faff, Robert, 2016. "Does the uncertainty of firm-level fundamentals help explain cross-sectional differences in liquidity commonality?," Journal of Banking & Finance, Elsevier, vol. 68(C), pages 153-161.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:oup:rfinst:v:27:y:2014:i:6:p:1615-1660.. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Oxford University Press) or (Christopher F. Baum). General contact details of provider: http://edirc.repec.org/data/sfsssea.html .

    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.

    We have no references for this item. You can help adding them by using 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 RePEc Author Service 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.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.