55 Pages Posted: 6 Dec 2019 Last revised: 8 Aug 2022
Date Written: August 8, 2022
This paper studies price and liquidity dynamics in the presence of costly short-selling when uninformed traders have limited willingness-to-pay to trade securities. In this setting, the combination of unravelling (Akerlof, 1970) and Bayesian social learning interact to produce a novel mechanism, dynamic unravelling: unravelling that generates signals that lead to future unravelling. Applying the theory, I show how dynamic unravelling provides an explanation for low volume crashes: falls in the prices of securities on low or declining trading volume. In this context, short-selling restrictions can make low volume crashes more likely by intensifying dynamic unravelling but liquidity injections have the opposite effect.
Keywords: Financial Crashes, Adverse Selection, Asymmetric Information, Short-Selling, Liquidity
JEL Classification: D53, D82, D83, G01, G14
Suggested Citation: Suggested Citation