Liquidity and Financial Market Runs

Antonio E. Bernardo and Ivo Welch

The Quarterly Journal of Economics, 2004, vol. 119, issue 1, 135-158

Abstract: We model a run on a financial market, in which each risk-neutral investor fears having to liquidate shares after a run, but before prices can recover back to fundamental values. To avoid having to possibly liquidate shares at the marginal postrun price—in which case the risk-averse market-making sector will already hold a lot of share inventory and thus be more reluctant to absorb additional shares—each investor may prefer selling today at the average in-run price, thereby causing the run itself. Liquidity runs and crises are not caused by liquidity shocks per se, but by the fear of future liquidity shocks.

Date: 2004
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Working Paper: Liquidity and Financial Market Runs (2003)
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