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Liquidity Black Holes

Author

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  • Hyun Song Shin
  • Stephen Morris

Abstract

Traders with short horizons and privately known trading limits interact in a market for a risky asset. Risk-averse, long horizon traders supply a downward sloping residual demand curve that face the short-horizon traders. When the price falls close to the trading limits of the short horizon traders, selling of the risky asset by any trader increases the incentives for others to sell. Sales becomes strategic complements between the short term traders, and payoffs analogous to a bank run are generated. A "liquidity black hole" is the analogue of the run outcome in a bank run model. Short horizon traders sell because others sell. Using global game techniques, this paper solves for the unique trigger point at which the liquidity black hole comes into existence. Empirical implications include the sharp V-shaped pattern in prices around the time of the liquidity black hole

Suggested Citation

  • Hyun Song Shin & Stephen Morris, 2004. "Liquidity Black Holes," Econometric Society 2004 North American Winter Meetings 620, Econometric Society.
    • Handle: RePEc:ecm:nawm04:620
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    liquidity; global games;

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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