Liquidity Black Holes

27 Pages Posted: 19 Sep 2003

See all articles by Stephen Morris

Stephen Morris

MIT

Hyun Song Shin

Bank for International Settlements (BIS)

Date Written: September 2003

Abstract

Traders with short horizons and privately known trading limits interact in a market for a risky asset. Risk-averse, long horizon traders supply a downward sloping residual demand curve that face the short-horizon traders. When the price falls close to the trading limits of the short horizon traders, selling of the risky asset by any trader increases the incentives for others to sell. Sales become mutually reinforcing among the short term traders, and payoffs analogous to a bank run are generated. A "liquidity black hole" is the analogue of the run outcome in a bank run model. Short horizon traders sell because others sell. Using global game techniques, this paper solves for the unique trigger point at which the liquidity black hole comes into existence. Empirical implications include the sharp V-shaped pattern in prices around the time of the liquidity black hole.

Keywords: Liquidity, asset pricing, global games

JEL Classification: C7, G12

Suggested Citation

Morris, Stephen Edward and Shin, Hyun Song, Liquidity Black Holes (September 2003). Cowles Foundation Discussion Paper No. 1434. Available at SSRN: https://ssrn.com/abstract=446600

Stephen Edward Morris (Contact Author)

MIT ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

HOME PAGE: http://https://economics.mit.edu/faculty/semorris

Hyun Song Shin

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

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