Dynamic Unravelling

55 Pages Posted: 6 Dec 2019 Last revised: 8 Aug 2022

See all articles by Joel P. Flynn

Joel P. Flynn

Massachusetts Institute of Technology (MIT) - Department of Economics

Date Written: August 8, 2022

Abstract

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

Flynn, Joel P., Dynamic Unravelling (August 8, 2022). Available at SSRN: https://ssrn.com/abstract=3496074 or http://dx.doi.org/10.2139/ssrn.3496074

Joel P. Flynn (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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E52-391
Cambridge, MA 02142
United States

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