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Do institutions behave rationally in distressed markets?

Author

Listed:
  • Cho, Hoon
  • Ryu, Doojin
  • Sung, Sangwook

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.

Suggested Citation

  • Cho, Hoon & Ryu, Doojin & Sung, Sangwook, 2017. "Do institutions behave rationally in distressed markets?," Economics Discussion Papers 2017-103, Kiel Institute for the World Economy (IfW Kiel).
    • Handle: RePEc:zbw:ifwedp:2017103
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    References listed on IDEAS

    as
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    4. Heejin Yang & Hyung‐Suk Choi & Doojin Ryu, 2017. "Option Market Characteristics and Price Monotonicity Violations," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 37(5), pages 473-498, May.
    5. Doojin Ryu, 2011. "Intraday price formation and bid–ask spread components: A new approach using a cross‐market model," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 31(12), pages 1142-1169, December.
    6. Liu, Xuewen & Mello, Antonio S., 2011. "The fragile capital structure of hedge funds and the limits to arbitrage," Journal of Financial Economics, Elsevier, vol. 102(3), pages 491-506.
    7. Lee, Jaeram & Kang, Jangkoo & Ryu, Doojin, 2015. "Common deviation and regime-dependent dynamics in the index derivatives markets," Pacific-Basin Finance Journal, Elsevier, vol. 33(C), pages 1-22.
    8. Hee‐Joon Ahn & Jangkoo Kang & Doojin Ryu, 2008. "Informed trading in the index option market: The case of KOSPI 200 options," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 28(12), pages 1118-1146, December.
    9. Doojin Ryu, 2015. "The Information Content of Trades: An Analysis of KOSPI 200 Index Derivatives," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 35(3), pages 201-221, March.
    10. Shleifer, Andrei & Vishny, Robert W, 1997. "The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    market efficiency; arbitrage profit; liquidity risk; flight to quality; distressed market;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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