The illiquidity network of stocks in China's market crash

Xiaoling Tan and Jichang Zhao

Papers from arXiv.org

Abstract: The Chinese stock market experienced an abrupt crash in 2015, and over one-third of its market value evaporated. Given its associations with fear and the fine resolution with respect to frequency, the illiquidity of stocks may offer a promising perspective for understanding and even signaling a market crash. In this study, by connecting stocks with illiquidity comovements, an illiquidity network is established to model the market. Compared to noncrash days, on crash days, the market is more densely connected due to heavier but more homogeneous illiquidity dependencies that facilitate abrupt collapses. Critical stocks in the illiquidity network, particularly those in the finance sector, are targeted for inspection because of their crucial roles in accumulating and passing on illiquidity losses. The cascading failures of stocks in market crashes are profiled as disseminating from small degrees to high degrees that are usually located in the core of the illiquidity network and then back to the periphery. By counting the days with random failures in the previous five days, an early signal is implemented to successfully predict more than half of the crash days, especially consecutive days in the early phase. Additional evidence from both the Granger causality network and the random network further testifies to the robustness of the signal. Our results could help market practitioners such as regulators detect and prevent the risk of crashes in advance.

Date: 2020-04, Revised 2021-11
New Economics Papers: this item is included in nep-cna, nep-net and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2004.01917

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