Liquidity Shocks and Stock Bubbles

30 Pages Posted: 11 Jul 2013 Last revised: 2 Jan 2014

See all articles by Ogonna Nneji

Ogonna Nneji

University of Reading - ICMA Centre

Date Written: January 2014

Abstract

This study presents and empirically tests a simple framework that examines the effects of market liquidity (the ease with which stocks are traded) and funding liquidity (the ease with which market participants can obtain funding) on stock market bubbles. Three key findings emerge from this research. First, negative market and funding liquidity shocks increase the probability of stock market bubbles collapsing. Second, market liquidity has a more prevalent effect on stock bubbles than funding liquidity. Third, liquidity shocks provide warning signals of impending bubble collapses. A trading rule based on recursive forecasts from the aforementioned framework is used to illustrate the economic significance of the liquidity-bubble relationship.

Keywords: funding liquidity, market liquidity, liquidity shocks, speculative bubble, trading

JEL Classification: C13, C51, C58, G12

Suggested Citation

Nneji, Ogonna, Liquidity Shocks and Stock Bubbles (January 2014). Available at SSRN: https://ssrn.com/abstract=2292171 or http://dx.doi.org/10.2139/ssrn.2292171

Ogonna Nneji (Contact Author)

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom

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