Crashes and Recoveries in Illiquid Markets

Pierre-Olivier Weill, Guillaume Rocheteau and Ricardo Lagos

No 981, 2007 Meeting Papers from Society for Economic Dynamics

Abstract: We study the dynamics of dealers' inventories during an asset market crash, described as a temporary, negative shock to outside investors' aggregate asset demand. We consider a class of dynamic market settings where trading between dealers and outside investors is subject to delays and requires bargaining. We show that dealers are more likely to accumulate inventories when the crash is severe and expected to be short-lived, when the elasticity of investors' asset demand is in some intermediate range, and when trading delays are neither too small nor too large. Giving dealers market power can either increase or decrease the equilibrium amount of inventory they accumulate, but will always reduce welfare.

Date: 2007
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Related works:
Working Paper: Crashes and Recoveries in Illiquid Markets (2008)
Working Paper: Crashes and recoveries in illiquid markets (2007)
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