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Market run-ups, market freezes, inventories, and leverage

  • Philip Bond
  • Yaron Leitner
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    This paper supersedes Working Paper No. 12-8.> We study trade between an informed seller and an uninformed buyer who have existing inventories of assets similar to those being traded. We show that these inventories may lead to prices that increase even absent changes in fundamentals (a .run-up.), but may also make trade impossible (a .freeze.) and hamper information dissemination. Competition may amplify the run-up by inducing buyers to enter loss-making trades at high prices to prevent a competitor from purchasing at a lower price and releasing bad news about inventory values. Inventories also prevent seller competition from delivering the Bertrand outcome, in which prices match sellers’ valuations. We discuss both empirical implications and implications for regulatory intervention in illiquid markets.

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    Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 13-14.

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    Date of creation: 2013
    Date of revision: 04 Feb 2014
    Handle: RePEc:fip:fedpwp:13-14
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