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Do institutions behave rationally in distressed markets?

Hoon Cho, Doojin Ryu and Sangwook Sung

No 2017-103, Economics Discussion Papers from Kiel Institute for the World Economy (IfW)

Abstract: The authors theoretically analyze the efficiency of liquidity flows in stabilizing distressed markets. Their analysis focuses on the incentives for financial institutions; specifically, they focus on arbitrage profit as an incentive and liquidity risk as a disincentive. The authors show that even with a major negative market shock, a financial institution can increase its market investment if it has sufficient funding liquidity. In addition, their model reveals a positive relationship between funding liquidity and liquidity flows. Thus, a distressed market might stabilize more quickly when financial institutions, acting as liquidity providers, have sufficient funding to bear the market's liquidity risk.

Keywords: market efficiency; arbitrage profit; liquidity risk; flight to quality; distressed market (search for similar items in EconPapers)
JEL-codes: G14 G18 G21 (search for similar items in EconPapers)
Date: 2017
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