Illiquidity Contagion and Liquidity Crashes

Giovanni Cespa and Thierry Foucault

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Abstract: Liquidity providers often learn information about an asset from prices of other assets. We show that this generates a self-reinforcing positive relationship between price informativeness and liquidity. This relationship causes liquidity spillovers and is a source of fragility: a small drop in the liquidity of one asset can, through a feedback loop, result in a very large drop in market liquidity and price informativeness (a liquidity crash). This feedback loop provides a new explanation for comovements in liquidity and liquidity dry-ups. It also generates multiple equilibria.

Keywords: Liquidity spillovers; Contagion; Liquidity Crashes; Multiple equilibria; Rational expectations (search for similar items in EconPapers)
Date: 2014-06
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Citations: View citations in EconPapers (69)

Published in Review of Financial Studies, 2014, 27 (6), pp.1615-1660. ⟨10.1093/rfs/hhu016⟩

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Journal Article: Illiquidity Contagion and Liquidity Crashes (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-00998274

DOI: 10.1093/rfs/hhu016

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