IDEAS home Printed from https://ideas.repec.org/a/oup/qjecon/v119y2004i1p135-158..html
   My bibliography  Save this article

Liquidity and Financial Market Runs

Author

Listed:
  • Antonio E. Bernardo
  • Ivo Welch

Abstract

We model a run on a financial market, in which each risk-neutral investor fears having to liquidate shares after a run, but before prices can recover back to fundamental values. To avoid having to possibly liquidate shares at the marginal postrun price—in which case the risk-averse market-making sector will already hold a lot of share inventory and thus be more reluctant to absorb additional shares—each investor may prefer selling today at the average in-run price, thereby causing the run itself. Liquidity runs and crises are not caused by liquidity shocks per se, but by the fear of future liquidity shocks.

Suggested Citation

  • Antonio E. Bernardo & Ivo Welch, 2004. "Liquidity and Financial Market Runs," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 119(1), pages 135-158.
    • Handle: RePEc:oup:qjecon:v:119:y:2004:i:1:p:135-158.
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1162/003355304772839542
    Download Restriction: Access to full text is restricted to subscribers.
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Brennan, Michael J & Schwartz, Eduardo S, 1989. "Portfolio Insurance and Financial Market Equilibrium," The Journal of Business, University of Chicago Press, vol. 62(4), pages 455-472, October.
    2. Baumol, William J, 1982. "Contestable Markets: An Uprising in the Theory of Industry Structure," American Economic Review, American Economic Association, vol. 72(1), pages 1-15, March.
    3. Madhavan, Ananth & Smidt, Seymour, 1993. "An Analysis of Changes in Specialist Inventories and Quotations," Journal of Finance, American Finance Association, vol. 48(5), pages 1595-1628, December.
    4. Ray C. Fair, 2002. "Events That Shook the Market," The Journal of Business, University of Chicago Press, vol. 75(4), pages 713-732, October.
    5. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    6. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
    7. Dow, James & Gorton, Gary, 1994. "Arbitrage Chains," Journal of Finance, American Finance Association, vol. 49(3), pages 819-849, July.
    8. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-738, August.
    9. Jun Liu, 2004. "Losing Money on Arbitrage: Optimal Dynamic Portfolio Choice in Markets with Arbitrage Opportunities," The Review of Financial Studies, Society for Financial Studies, vol. 17(3), pages 611-641.
    10. Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272.
    11. Greenwald, Bruce C & Stein, Jeremy, 1988. "The Task Force Report: The Reasoning behind the Recommendations," Journal of Economic Perspectives, American Economic Association, vol. 2(3), pages 3-23, Summer.
    12. Welch, Ivo, 1992. "Sequential Sales, Learning, and Cascades," Journal of Finance, American Finance Association, vol. 47(2), pages 695-732, June.
    13. G. William Schwert, 1997. "Stock Market Volatility: Ten Years After the Crash," Center for Financial Institutions Working Papers 97-51, Wharton School Center for Financial Institutions, University of Pennsylvania.
    14. Grossman, Sanford J, 1988. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," The Journal of Business, University of Chicago Press, vol. 61(3), pages 275-298, July.
    15. Chowdhry, Bhagwan & Nanda, Vikram, 1998. "Leverage and Market Stability: The Role of Margin Rules and Price Limits," The Journal of Business, University of Chicago Press, vol. 71(2), pages 179-210, April.
    16. Romer, David, 1993. "Rational Asset-Price Movements without News," American Economic Review, American Economic Association, vol. 83(5), pages 1112-1130, December.
    17. Ho, Thomas & Stoll, Hans R., 1981. "Optimal dealer pricing under transactions and return uncertainty," Journal of Financial Economics, Elsevier, vol. 9(1), pages 47-73, March.
    18. Leland, Hayne & Rubinstein, Mark, 1988. "Comments on the Market Crash: Six Months After," Journal of Economic Perspectives, American Economic Association, vol. 2(3), pages 45-50, Summer.
    19. Sandroni, Alvaro, 1998. "Learning, Rare Events, and Recurrent Market Crashes in Frictionless Economies without Intrinsic Uncertainty," Journal of Economic Theory, Elsevier, vol. 82(1), pages 1-18, September.
    20. Gammill, James F, Jr & Marsh, Terry A, 1988. "Trading Activity and Price Behavior in the Stock and Stock Index Futures Markets in October 1987," Journal of Economic Perspectives, American Economic Association, vol. 2(3), pages 25-44, Summer.
    21. Patrick J. Dennis & Deon Strickland, 2002. "Who Blinks in Volatile Markets, Individuals or Institutions?," Journal of Finance, American Finance Association, vol. 57(5), pages 1923-1949, October.
    22. Donaldson, R Glen & Uhlig, Harald, 1993. "The Impact of Large Portfolio Insurers on Asset Prices," Journal of Finance, American Finance Association, vol. 48(5), pages 1943-1955, December.
    23. Basak, Suleyman, 1995. "A General Equilibrium Model of Portfolio Insurance," The Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 1059-1090.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Antonio E. Bernardo & Ivo Welch, 2002. "Financial Market Runs," NBER Working Papers 9251, National Bureau of Economic Research, Inc.
    2. Sushant Acharya & Keshav Dogra & Sanjay R. Singh, 2021. "The financial origins of non-fundamental risk," Working Papers 345, University of California, Davis, Department of Economics.
    3. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
    4. Vayanos, Dimitri & Wang, Jiang, 2013. "Market Liquidity—Theory and Empirical Evidence ," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1289-1361, Elsevier.
    5. Jennifer Huang & Jiang Wang, 2009. "Liquidity and Market Crashes," The Review of Financial Studies, Society for Financial Studies, vol. 22(7), pages 2407-2443, July.
    6. Hirshleifer, David & Teoh, Siew Hong, 2008. "Thought and Behavior Contagion in Capital Markets," MPRA Paper 9142, University Library of Munich, Germany.
    7. Devenow, Andrea & Welch, Ivo, 1996. "Rational herding in financial economics," European Economic Review, Elsevier, vol. 40(3-5), pages 603-615, April.
    8. Brunnermeier, Markus K. & Oehmke, Martin, 2013. "Bubbles, Financial Crises, and Systemic Risk," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1221-1288, Elsevier.
    9. Joel M. Vanden, 2006. "Portfolio Insurance And Volatility Regime Switching," Mathematical Finance, Wiley Blackwell, vol. 16(2), pages 387-417, April.
    10. Adlai Fisher, 1999. "Multivariate Stock Returns Around Extreme Events: A Reassessment of Economic Fundamentals and the 1987 Market Crash," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-071, New York University, Leonard N. Stern School of Business-.
    11. Kryzanowski, Lawrence & Switzer, Lorne & Jiang, Li, 1995. "Stock market crash behavior of screen-sorted portfolios," International Review of Economics & Finance, Elsevier, vol. 4(3), pages 227-244.
    12. Adrian, Tobias & Borowiecki, Karol Jan & Tepper, Alexander, 2022. "A leverage-based measure of financial stability," Journal of Financial Intermediation, Elsevier, vol. 51(C).
    13. Rüdiger Frey & Alexander Stremme, 1997. "Market Volatility and Feedback Effects from Dynamic Hedging," Mathematical Finance, Wiley Blackwell, vol. 7(4), pages 351-374, October.
    14. Ilhyock Shim & Goetz Von Peter, 2007. "Distress Selling and Asset Market Feedback," Financial Markets, Institutions & Instruments, John Wiley & Sons, vol. 16(5), pages 243-291, December.
    15. Chen, Joseph & Hong, Harrison & Stein, Jeremy C., 2001. "Forecasting crashes: trading volume, past returns, and conditional skewness in stock prices," Journal of Financial Economics, Elsevier, vol. 61(3), pages 345-381, September.
    16. Gabaix, Xavier & Gopikrishnan, Parameswaran & Plerou, Vasiliki & Eugene Stanley, H., 2008. "Quantifying and understanding the economics of large financial movements," Journal of Economic Dynamics and Control, Elsevier, vol. 32(1), pages 303-319, January.
    17. Xavier Gabaix & Parameswaran Gopikrishnan & Vasiliki Plerou & H. Eugene Stanley, 2006. "Institutional Investors and Stock Market Volatility," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 121(2), pages 461-504.
    18. Bernhard Nietert, 1999. "Dynamische Portfolio-Selektion unter Berücksichtigung von Kurssprüngen," Schmalenbach Journal of Business Research, Springer, vol. 51(9), pages 832-866, September.
    19. Elettra Agliardi & Rainer Andergassen, 2007. "(S,S)-Adjustment Strategies And Dynamic Hedging," Working Paper series 09_07, Rimini Centre for Economic Analysis.
    20. Adrian, Tobias, 2009. "Inference, arbitrage, and asset price volatility," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 49-64, January.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:oup:qjecon:v:119:y:2004:i:1:p:135-158.. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Oxford University Press (email available below). General contact details of provider: https://academic.oup.com/qje .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.