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On the impact of fundamentals, liquidity and coordination on market stability

  • Francisco Peñaranda
  • Jón Daníelsson

We develop a coordination game to model interactions between fundamentals and liquidity during unstable periods in financial markets. We then propose a flexible econometric framework for estimation of the model and analysis of its quantitative implications. The specific empirical application is carry trades in the yen–dollar market, including the turmoil of 1998. We find a generally very deep market, with low information disparities amongst agents. We observe occasionally episodes of market fragility, or turmoil with up by the escalator, down by the elevator patterns in prices. The key role of strategic behavior in the econometric model is also confirmed.

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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1003.

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Date of creation: Jan 2007
Date of revision: Mar 2010
Handle: RePEc:upf:upfgen:1003
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  1. Grossman, S.J. & Miller, M.H., 1988. "Liquidity And Market Structure," Papers 88, Princeton, Department of Economics - Financial Research Center.
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  4. Dasgupta, Amil, 2007. "Coordination and delay in global games," Journal of Economic Theory, Elsevier, vol. 134(1), pages 195-225, May.
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  11. Maurice Obstfeld, 1984. "Rational and Self-Fulfilling Balance-of-Payments Crises," NBER Working Papers 1486, National Bureau of Economic Research, Inc.
  12. Tauchen, George E. & Gallant, A. Ronald, 1995. "Which Moments to Match," Working Papers 95-20, Duke University, Department of Economics.
  13. Ravi Bansal & Hao Zhou, 2001. "Term structure of interest rates with regime shifts," Finance and Economics Discussion Series 2001-46, Board of Governors of the Federal Reserve System (U.S.).
  14. Martin D. D. Evans and Richard K. Lyons., 1999. "Order Flow and Exchange Rate Dynamics," Research Program in Finance Working Papers RPF-288, University of California at Berkeley.
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  17. Gallant, A. Ronald & Tauchen, George, 2002. "Simulated Score Methods and Indirect Inference for Continuous-time Models," Working Papers 02-09, Duke University, Department of Economics.
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  19. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  20. Stephen Morris & Hyun Song Shin, 2003. "Liquidity Black Holes," Cowles Foundation Discussion Papers 1434, Cowles Foundation for Research in Economics, Yale University.
  21. Morris, Stephen & Shin, Hyun Song, 1997. "Unique Equilibrium in a Model of Self-fulfilling Currency Attacks," CEPR Discussion Papers 1687, C.E.P.R. Discussion Papers.
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  25. repec:cup:etheor:v:12:y:1996:i:4:p:657-81 is not listed on IDEAS
  26. Itay Goldstein & Ady Pauzner, 2005. "Demand-Deposit Contracts and the Probability of Bank Runs," Journal of Finance, American Finance Association, vol. 60(3), pages 1293-1327, 06.
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