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Financial Market Runs

  • Bernardo, Antonio E.
  • Welch, Ivo

Our paper o�ers a minimalist model of a run on a financial market. The prime ingredient is that each risk-neutral investor fears having to liquidate after a run, but before prices can recover back to fundamental values. During the run, only the risk-averse market-making sector is willing to absorb shares. To avoid having to possibly liquidate shares at the marginal post-run price—in which case the market-making sector will already hold a lot of share inventory and thus be more reluctant to absorb additional shares—all investors may prefer selling their shares into the market today at the average run price, thereby causing the run itself. Consequently, stock prices are low and risk is allocated ineciently. Liquidity runs and crises are not caused by liquidity shocks per se, but by the fear of future liquidity shocks.

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Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number qt0zd313hf.

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Date of creation: 18 Nov 2002
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Handle: RePEc:cdl:anderf:qt0zd313hf
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Web page: http://www.escholarship.org/repec/anderson_fin/
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  1. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
  2. Dilip Abreu & Markus K. Brunnermeier, 2003. "Bubbles and Crashes," Econometrica, Econometric Society, vol. 71(1), pages 173-204, January.
  3. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  4. Ricardo J. Caballero & Arvind Krishnamurthy, 2001. "International Liquidity Illusion: On the Risks of Sterilization," NBER Working Papers 8141, National Bureau of Economic Research, Inc.
  5. James Dow & Gary Gorton, . "Arbitrage Chains," Rodney L. White Center for Financial Research Working Papers 6-93, Wharton School Rodney L. White Center for Financial Research.
  6. Chowdhry, Bhagwan & Nanda, Vikram, 1998. "Leverage and Market Stability: The Role of Margin Rules and Price Limits," The Journal of Business, University of Chicago Press, vol. 71(2), pages 179-210, April.
  7. Franklin Allen & Stephen Morris & Hyun Song Shin, 2003. "Beauty Contests, Bubbles and Iterated Expectations in Asset Markets," Cowles Foundation Discussion Papers 1406, Cowles Foundation for Research in Economics, Yale University.
  8. Sushil Bikhchandani & David Hirshleifer & Ivo Welch, 2010. "A theory of Fads, Fashion, Custom and cultural change as informational Cascades," Levine's Working Paper Archive 1193, David K. Levine.
  9. Brennan, Michael J & Schwartz, Eduardo S, 1989. "Portfolio Insurance and Financial Market Equilibrium," The Journal of Business, University of Chicago Press, vol. 62(4), pages 455-72, October.
  10. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania.
  11. Basak, Suleyman, 1995. "A General Equilibrium Model of Portfolio Insurance," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 1059-90.
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