Liquidity and Financial Market Runs
35 Pages Posted: 15 Jul 2003
Date Written: May 27, 2003
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