Financial Contagion and Market Liquidity - Evidence from the Asian Crisis

61 Pages Posted: 2 Mar 2005

See all articles by Shantaram P. Hegde

Shantaram P. Hegde

University of Connecticut - School of Business

Rupendra Paliwal

John F. Welch College of Business, Sacred Heart University

Date Written: February 23, 2005

Abstract

Models of financial crisis and contagion predict that an economic crisis turns into a financial liquidity crisis in the presence of borrowing constraints, information asymmetry and risk aversion, and it culminates in a crisis in market liquidity through portfolio recomposition. We use firm level data to examine changes in the stock market liquidity of exposed and unexposed firms to the Asian crisis. Our results indicate a significant increase in the crisis period bid-ask spreads and decrease in quoted depth for both exposed and unexposed firms, particularly the more liquid or less risky firms during the pre-crisis period. The drop in crisis period market liquidity seems to be attributable to an increase in margin-induced sales, risk aversion, and both the asymmetric information and fixed costs of trading. Finally, we find that the increase in liquidity costs provides a partial explanation for the crisis-induced abnormal returns.

Keywords: Contagion, Market Liquidity, Crisis

JEL Classification: F30, F40, G15

Suggested Citation

Hegde, Shantaram P. and Paliwal, Rupendra, Financial Contagion and Market Liquidity - Evidence from the Asian Crisis (February 23, 2005). Available at SSRN: https://ssrn.com/abstract=671902 or http://dx.doi.org/10.2139/ssrn.671902

Shantaram P. Hegde (Contact Author)

University of Connecticut - School of Business ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States
860-486-5135 (Phone)

Rupendra Paliwal

John F. Welch College of Business, Sacred Heart University ( email )

5151 Park Avenue
Fairfield, CT 06432
United States
203-371-7851 (Phone)

HOME PAGE: http://business.sacredheart.edu/

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