Common Liquidity Shocks and Market Collapse: Lessons from the Market for Perps

30 Pages Posted: 13 Mar 2008

See all articles by Chitru S. Fernando

Chitru S. Fernando

University of Oklahoma - Michael F. Price College of Business

Richard J. Herring

University of Pennsylvania - Finance Department

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School; Financial Research Network (FIRN)

Abstract

We show how a high degree of commonality in investor liquidity shocks can diminish incentives for intermediaries to keep markets open and lead to market collapse, even without information asymmetry or news affecting fundamentals. We motivate our model using the perpetual floating rate note market where two years of explosive growth - in which issues by high quality borrowers were placed with institutional investors and traded in a liquid secondary market - were followed by a precipitous collapse when market intermediaries withdrew due to large order imbalances. We shed new light on the trade-off between ownership concentration and market liquidity.

Keywords: ownership concentration, intermediation, market liquidity, common liquidity shocks, market collapse

JEL Classification: G12, G15, G18

Suggested Citation

Fernando, Chitru S. and Herring, Richard J. and Subrahmanyam, Avanidhar, Common Liquidity Shocks and Market Collapse: Lessons from the Market for Perps. Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1105395

Chitru S. Fernando (Contact Author)

University of Oklahoma - Michael F. Price College of Business ( email )

Adams Hall
307 West Brooks Street
Norman, OK 73019-4004
United States
405-325-2906 (Phone)
405-325-7688 (Fax)

HOME PAGE: http://faculty-staff.ou.edu/F/Chitru.Fernando-1/

Richard J. Herring

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-5613 (Phone)
215-898-2067 (Fax)

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Institute of Global Finance, UNSW Business School

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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