Liquidity contagion: A look at emerging markets

Serge Darolles, Jérémy Dudek and Gaelle Le Fol
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Jérémy Dudek: DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique, CREST - Centre de Recherche en Économie et Statistique - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz] - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - ENSAE Paris - École Nationale de la Statistique et de l'Administration Économique - IP Paris - Institut Polytechnique de Paris - CNRS - Centre National de la Recherche Scientifique

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Abstract: Financial markets are today so interconnected that they are fragile to contagion. Massive investment funds with very short horizons in -and out- flows can generate contagion effects between markets. Since 2010, investors are willing to get a liquid exposure to the EM sovereign debt. As a consequence, some asset management firms started to propose products to track the performance of this asset class. However in that case, the fund manager faces a mismatch of liquidity between assets and liabilities and needs some tools to manage the liquidity of his investments. The main contribution of this paper is the analysis of contagion looking at common market liquidity problems to detect funding liquidity problems. Using the CDS Bond Spread basis as a liquidity indicator and a state space model with time-varying volatility specification, we show that during the 2007-2008 financial crisis, there exist pure contagion effects both in terms of price and liquidity on the emerging sovereign debt market. This result has strong implication since the main risk for an asset manager is to get stuck with an unwanted position due to a dry-up of market liquidity.

Keywords: Emerging Markets; Sovereign Debt Market; Liquidity Risk Management; Liquidity; Contagion Effects; Regime Switching models (search for similar items in EconPapers)
Date: 2012-01-26
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Citations: View citations in EconPapers (1)

Published in 4th Annual Conference on Hedge Funds - Hedge Funds, Market Liquidity and Systemic Risk, Jan 2012, Paris, France

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:halshs-00877035

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