Liquidity Black Holes

Stephen Morris and Hyun Song Shin

No 1434, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: Traders with short horizons and privately known trading limits interact in a market for a risky asset. Risk-averse, long horizon traders supply a downward sloping residual demand curve that face the short-horizon traders. When the price falls close to the trading limits of the short horizon traders, selling of the risky asset by any trader increases the incentives for others to sell. Sales become mutually reinforcing among the short term traders, and payoffs analogous to a bank run are generated. A "liquidity black hole" is the analogue of the run outcome in a bank run model. Short horizon traders sell because others sell. Using global game techniques, this paper solves for the unique trigger point at which the liquidity black hole comes into existence. Empirical implications include the sharp V-shaped pattern in prices around the time of the liquidity black hole.

Keywords: Liquidity; Asset pricing; Global games (search for similar items in EconPapers)
JEL-codes: C7 G12 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2003-09
New Economics Papers: this item is included in nep-fmk, nep-mac and nep-rmg
Note: CFP 1114.
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

Published in Review of Finance (2004), 8(1): 1-18

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Journal Article: Liquidity Black Holes (2004)
Journal Article: Liquidity Black Holes (2004)
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Working Paper: Liquidity Black Holes (2004)
Working Paper: Liquidity Black Holes (2004)
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