On the Impact of Fundamentals, Liquidity and Coordination on Market Stability

34 Pages Posted: 25 Jul 2007

See all articles by Francisco Penaranda

Francisco Penaranda

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences

Jon Danielsson

London School of Economics - Systemic Risk Centre

Date Written: January 2007

Abstract

Complex interactions between fundamentals and liquidity during unstable periods in financial markets are succinctly modeled with coordination games. We propose a flexible framework to estimate such a model and use the efficient method of moments as estimation procedure. We illustrate the model by using exchange rates from the yen-dollar carry trade induced uncertainty in 1998, interest rate spreads and global market volatility. The model fits the data well, with evidence of low information disparities, the market is generally very deep, where global volatility is more important than fundamental uncertainty in the determination of liquidity. There is clear evidence of asymmetry between the buy and sell sides of the market.

Keywords: Carry trades, currency crises, efficient method of moments, global games

JEL Classification: C22, C51, F31, G15

Suggested Citation

Penaranda, Francisco and Danielsson, Jon, On the Impact of Fundamentals, Liquidity and Coordination on Market Stability (January 2007). Available at SSRN: https://ssrn.com/abstract=1002836 or http://dx.doi.org/10.2139/ssrn.1002836

Francisco Penaranda (Contact Author)

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain

Jon Danielsson

London School of Economics - Systemic Risk Centre ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44.207.955.6056 (Phone)

HOME PAGE: http://www.riskreasearch.org

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