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Financial Market Runs

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  • Antonio E. Bernardo
  • Ivo Welch

Abstract

Our paper offers 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 urn, 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 inefficiently. Liquidity runs and crises are not caused by liquidity shocks per se, but by the fear of future liquidity shocks.

Suggested Citation

  • Antonio E. Bernardo & Ivo Welch, 2002. "Financial Market Runs," NBER Working Papers 9251, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:9251
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    References listed on IDEAS

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    Cited by:

    1. Stephen Morris & Hyun Song Shin, 2004. "Liquidity Black Holes," Review of Finance, European Finance Association, vol. 8(1), pages 1-18.
    2. Tibor Neugebauer & Sascha Füllbrunn, 2013. "Deflating Bubbles in Experimental Asset Markets: Comparative Statics of Margin Regulations," LSF Research Working Paper Series 13-14, Luxembourg School of Finance, University of Luxembourg.
    3. Markus K. Brunnermeier & Lasse Heje Pedersen, 2005. "Predatory Trading," Journal of Finance, American Finance Association, vol. 60(4), pages 1825-1863, August.
    4. 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.
    5. Sascha Füllbrunn & Tibor Neugebauer, 2012. "Margin Trading Bans in Experimental Asset Markets," Jena Economics Research Papers 2012-058, Friedrich-Schiller-University Jena.

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    More about this item

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • G1 - Financial Economics - - General Financial Markets

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