Do institutions behave rationally in distressed markets?
Doojin Ryu and
No 2017-103, Economics Discussion Papers from Kiel Institute for the World Economy (IfW)
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)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:ifwedp:2017103
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