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Self-fulfilling liquidity dry-ups

Frederic Malherbe

No 185, Working Paper Research from National Bank of Belgium

Abstract: Secondary markets for long-term assets might be illiquid due to adverse selection. In a model in which moral hazard is confined to project initiation, I find that: (1) when agents expect a liquidity dry-up on such markets, they optimally choose to self-insure through the hoarding of non-productive but liquid assets; (2) such a response has negative externalities as it reduces ex-post market participation, which worsens adverse selection and dries up market liquidity; (3) liquidity dry-ups are Pareto inefficient equilibria; (4) the Government can rule them out. Additionally, when agents face idiosyncratic, privately known, illiquidity shocks, I show that: (5) it increases market liquidity; (6) illiquid agents are better-off when they can credibly disclose their liquidity position, but transparency has an ambiguous effect on risk-sharing possibilities.

Keywords: Liquidity; Liquidity Dry-ups; Financial Crises; Hoarding; Adverse Selection; Self-insurance (search for similar items in EconPapers)
JEL-codes: E44 G01 G11 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2010-03
New Economics Papers: this item is included in nep-cta, nep-fdg, nep-ias and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Journal Article: Self-Fulfilling Liquidity Dry-Ups (2014) Downloads
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