Financial Market Runs

Antonio E. Bernardo and Ivo Welch

No 9251, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Our paper offers a minimalist model of a run on a financial market. The prime ingredient is that each risk-neutral investor fears having to liquidate after a run, but before prices can recover back to fundamental values. During the urn, only the risk-averse market-making sector is willing to absorb shares. To avoid having to possibly liquidate shares at the marginal post-run price in which case the market-making sector will already hold a lot of share inventory and thus be more reluctant to absorb additional shares all investors may prefer selling their shares into the market today at the average run price, thereby causing the run itself. Consequently, stock prices are low and risk is allocated inefficiently. Liquidity runs and crises are not caused by liquidity shocks per se, but by the fear of future liquidity shocks.

JEL-codes: G1 G2 (search for similar items in EconPapers)
Date: 2002-10
New Economics Papers: this item is included in nep-fin, nep-fmk and nep-rmg
Note: AP CF
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Published as Bernardo, Antonio and Ivo Welch. "Liquidity and Financial Market Runs." Quarterly Journal of Economics 119-1 (February 2004): 135-158.

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