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Liquidity Black Holes

Author

Listed:
  • Stephen Morris

    () (Yale University, Cowles Foundation)

  • Hyun Song Shin

    () (University of London, London School of Economics & Political Science (LSE), Department of Accounting and Finance)

Abstract

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 become mutually reinforcing among 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.

Suggested Citation

  • Stephen Morris & Hyun Song Shin, 2004. "Liquidity Black Holes," Yale School of Management Working Papers ysm425, Yale School of Management.
  • Handle: RePEc:ysm:somwrk:ysm425
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    References listed on IDEAS

    as
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    9. Stephen Morris & Hyun Song Shin, 2000. "Global Games: Theory and Applications," Cowles Foundation Discussion Papers 1275, Cowles Foundation for Research in Economics, Yale University.
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    More about this item

    Keywords

    Liquidity; asset pricing; global games;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory

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