publication . Article . Other literature type . 2014

Illiquidity Contagion and Liquidity Crashes

Thierry Foucault; Giovanni Cespa;

Open Access

Published: 01 Jun 2014 Journal: Review of Financial Studies, volume 27, pages 1,615-1,660 (issn: 0893-9454, eissn: 1465-7368,

Publisher: Oxford University Press (OUP)

Summary

Abstract

International audience; Liquidity providers often learn information about an asset from prices of other assets. We show that this generates a self-reinforcing positive relationship between price informativeness and liquidity. This relationship causes liquidity spillovers and is a source of fragility: a small drop in the liquidity of one asset can, through a feedback loop, result in a very large drop in market liquidity and price informativeness (a liquidity crash). This feedback loop provides a new explanation for comovements in liquidity and liquidity dry-ups. It also generates multiple equilibria.

doi: 10.1093/rfs/hhu016 , 10.2139/ssrn.1804351

Subjects

free text keywords: Economics and Econometrics, Accounting, Finance, Liquidity spillovers, Contagion, Liquidity Crashes, Multiple equilibria, JEL: G - Financial Economics/G.G1 - General Financial Markets/G.G1.G10 - General, JEL: G - Financial Economics/G.G1 - General Financial Markets/G.G1.G12 - Asset Pricing • Trading Volume • Bond Interest Rates, JEL: G - Financial Economics/G.G1 - General Financial Markets/G.G1.G14 - Information and Market Efficiency • Event Studies • Insider Trading, [SHS.GESTION.FIN]Humanities and Social Sciences/Business administration/domain_shs.gestion.fin, JEL : G - Financial Economics/G.G1 - General Financial Markets/G.G1.G10 - General, JEL : G - Financial Economics/G.G1 - General Financial Markets/G.G1.G12 - Asset Pricing • Trading Volume • Bond Interest Rates, JEL : G - Financial Economics/G.G1 - General Financial Markets/G.G1.G14 - Information and Market Efficiency • Event Studies • Insider Trading, [ SHS.GESTION.FIN ] Humanities and Social Sciences/Business administration/domain_shs.gestion.fin, Market impact, Fragility, Economics, Accounting liquidity, Market liquidity, Financial system, Liquidity premium, Liquidity crisis, Liquidity risk, Rational expectations

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