Liquidity and Financial Market Runs

Bernardo, Antonio E.; Welch, Ivo

Liquidity and Financial Market Runs

Yale ICF Working Paper No. 02-11; AFA 2003 Washington, DC Meetings

35 Pages Posted: 15 Jul 2003

See all articles by Antonio E. Bernardo

Antonio E. Bernardo

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

Ivo Welch

University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)

Date Written: May 27, 2003

Abstract

We model a run on a financial market, in which each risk-neutral investor fears having to liquidate shares after a run, but before prices can recover back to fundamental values. To avoid having to possibly liquidate shares at the marginal post-run price - in which case the risk-averse market-making sector will already hold a lot of share inventory and thus be more reluctant to absorb additional shares - each investor may prefer selling today at the average in-run price, thereby causing the run itself. Liquidity runs and crises are not caused by liquidity shocks per se, but by the fear of future liquidity shocks.

JEL Classification: G1, G2, G21, E44, N2

Suggested Citation: Suggested Citation

Bernardo, Antonio E. and Welch, Ivo, Liquidity and Financial Market Runs (May 27, 2003). Yale ICF Working Paper No. 02-11; AFA 2003 Washington, DC Meetings. Available at SSRN: https://ssrn.com/abstract=307719