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

50 Pages Posted: 3 Dec 2004

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)

Date Written: July 2006

Abstract

We study the collapse of the market for perpetual floating rate notes (perps). The perp market was launched in 1984, and its first two years were characterized by explosive growth in which issues by high quality borrowers were placed with institutional investors and traded in liquid secondary markets. However, the perp market began collapsing precipitously in December 1986, due to the withdrawal of market intermediaries prompted by large order imbalances. Although most of the original perps remain outstanding, prices and liquidity have not recovered. We develop a model to explain the events observed in the perp market and to draw lessons on how commonality in liquidity can affect market performance and intermediary incentives. We provide new insights into how markets can collapse even in the absence of information asymmetry or bubbles. We also contribute to the corporate governance literature by providing a new rationale for placing securities with a broad investor base -- to minimize the possibility that common liquidity shocks will cause a market to fail.

Keywords: ownership structure, monitoring, market liquidity, common liquidity risk, market collapse

JEL Classification: G12, G15, G18

Suggested Citation

Fernando, Chitru S. and Herring, Richard J. and Subrahmanyam, Avanidhar, Common Liquidity Risk and Market Collapse: Lessons from the Market for Perps (July 2006). AFA 2002 Atlanta Meetings, Forthcoming. Available at SSRN: https://ssrn.com/abstract=283194 or http://dx.doi.org/10.2139/ssrn.283194

Chitru S. Fernando

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 (Contact Author)

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

Register to save articles to
your library

Register

Paper statistics

Downloads
895
rank
24,938
Abstract Views
3,827
PlumX Metrics
!

Under construction: SSRN citations while be offline until July when we will launch a brand new and improved citations service, check here for more details.

For more information