Liquidity and Market Crashes

Jennifer Huang and Jiang Wang

No 14013, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In this paper, we develop an equilibrium model for stock market liquidity and its impact on asset prices when constant market presence is costly. We show that even when agents' trading needs are perfectly matched, costly market presence prevents them from synchronizing their trades and hence gives rise to endogenous order imbalances and the need for liquidity. Moreover, the endogenous liquidity need, when it occurs, is characterized by excessive selling of significant magnitudes. Such liquidity-driven selling leads to market crashes in the absence of any aggregate shocks. Finally, we show that illiquidity in the market leads to high expected returns, negative and asymmetric return serial correlation, and a positive relation between trading volume and future returns. We also propose new measures of liquidity based on its asymmetric impact on prices and demonstrate a negative relation between these measures and expected stock returns.

JEL-codes: E43 E44 G11 G12 (search for similar items in EconPapers)
Date: 2008-05
New Economics Papers: this item is included in nep-bec, nep-cfn, nep-mac and nep-mst
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

Published as Jennifer Huang & Jiang Wang, 2009. "Liquidity and Market Crashes," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 22(7), pages 2407-2443, July.

Downloads: (external link)
http://www.nber.org/papers/w14013.pdf (application/pdf)

Related works:
Journal Article: Liquidity and Market Crashes (2009)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:14013

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w14013

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().