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Liquidity Black Holes

  • Hyun Song Shin
  • Stephen Morris

Traders with short horizons and privately known trading limits interact in a market for a risky asset. Risk-averse, long horizon traders supply a downward sloping residual demand curve that face the short-horizon traders. When the price falls close to the trading limits of the short horizon traders, selling of the risky asset by any trader increases the incentives for others to sell. Sales becomes strategic complements between the short term traders, and payoffs analogous to a bank run are generated. A "liquidity black hole" is the analogue of the run outcome in a bank run model. Short horizon traders sell because others sell. Using global game techniques, this paper solves for the unique trigger point at which the liquidity black hole comes into existence. Empirical implications include the sharp V-shaped pattern in prices around the time of the liquidity black hole

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Paper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 620.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nawm04:620
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  1. Hanno Lustig, 2001. "The Market Price of Aggregate Risk and the Wealth Distribution," Finance 0111004, EconWPA, revised 16 Nov 2001.
  2. Dilip Abreu & Markus K. Brunnermeier, 2003. "Bubbles and Crashes," Econometrica, Econometric Society, vol. 71(1), pages 173-204, January.
  3. Morris, Stephen & Shin, Hyun Song, 1998. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," American Economic Review, American Economic Association, vol. 88(3), pages 587-97, June.
  4. Sanford J. Grossman & Merton H. Miller, 1988. "Liquidity and Market Structure," NBER Working Papers 2641, National Bureau of Economic Research, Inc.
  5. 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.
  6. Benjamin H. Cohen & Hyun Song Shin, 2003. "Positive feedback trading under stress: Evidence from the US Treasury securities market," BIS Working Papers 122, Bank for International Settlements.
  7. Denis Gromb & Dimitri Vayanos, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," LSE Research Online Documents on Economics 448, London School of Economics and Political Science, LSE Library.
  8. Jon Danielsson & Hyun Song Shin & Jean-Pierre Zigrand, 2004. "The impact of risk regulation on price dynamics," LSE Research Online Documents on Economics 16628, London School of Economics and Political Science, LSE Library.
  9. Markus K. Brunnermeier & Lasse Heje Pederson, 2003. "Predatory trading," LSE Research Online Documents on Economics 24829, London School of Economics and Political Science, LSE Library.
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  13. Stephen Morris & Hyun Song Shin, 2000. "Global Games: Theory and Applications," Cowles Foundation Discussion Papers 1275R, Cowles Foundation for Research in Economics, Yale University, revised Aug 2001.
  14. Lubos Pastor & Robert F. Stambaugh, 2001. "Liquidity Risk and Expected Stock Returns," NBER Working Papers 8462, National Bureau of Economic Research, Inc.
  15. Schnabel, Isabel & Shin, Hyun Song, 2001. "Foreshadowing LTCM: The Crisis of 1763," Sonderforschungsbereich 504 Publications 02-46, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
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  17. Campbell, John Y & Grossman, Sanford J & Wang, Jiang, 1993. "Trading Volume and Serial Correlation in Stock Returns," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 905-39, November.
  18. Evans, Martin D.D. & Lyons, Richard K., 2008. "How is macro news transmitted to exchange rates?," Journal of Financial Economics, Elsevier, vol. 88(1), pages 26-50, April.
  19. Bengt Holmstrom & Jean Tirole, 1998. "LAPM: A Liquidity Based Asset Pricing Model," Working papers 98-8, Massachusetts Institute of Technology (MIT), Department of Economics.
  20. Bengt Holmström, 2001. "LAPM: A Liquidity-Based Asset Pricing Model," Journal of Finance, American Finance Association, vol. 56(5), pages 1837-1867, October.
  21. Antonio E. Bernardo & Ivo Welch, 2002. "Financial Market Runs," NBER Working Papers 9251, National Bureau of Economic Research, Inc.
  22. Max Bruche, 2002. "A structural model of corporate bond pricing with co-ordination failure," LSE Research Online Documents on Economics 24930, London School of Economics and Political Science, LSE Library.
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