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Market Freezes

Author

Listed:
  • Chao Gu
  • Guido Menzio
  • Randall Wright
  • Yu Zhu

Abstract

During the financial crisis apparently centralized markets continued to function while trade in OTC markets froze. We use search-and-bargaining theory to ascertain conditions that allow trade to temporarily freeze in decentralized markets, focusing on the roles of liquidity and self-fulfilling prophecies. We show standard models can have recurrent, belief-driven hot and cold spells, but not freezes and thaws. A simple specification that has freezes assumes negative returns. A more realistic one incorporates information frictions (costly asset-quality verification). Another uses different frictions to get credit freezes. We also discuss policy implications, and go into detail on the nature of OTC markets.

Suggested Citation

  • Chao Gu & Guido Menzio & Randall Wright & Yu Zhu, 2021. "Market Freezes," NBER Working Papers 29210, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:29210
    Note: EFG ME
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    File URL: http://www.nber.org/papers/w29210.pdf
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    More about this item

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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