Crashes and Recoveries in Illiquid Markets

69 Pages Posted: 22 Jun 2008 Last revised: 30 Jan 2022

See all articles by Ricardo Lagos

Ricardo Lagos

New York University (NYU) - Department of Economics

Guillaume Rocheteau

Federal Reserve Bank of Cleveland; National University of Singapore (NUS)

Pierre-Olivier Weill

University of California, Los Angeles; National Bureau of Economic Research (NBER)

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Date Written: June 2008

Abstract

We study the dynamics of liquidity provision by dealers during an asset market crash, described as a temporary negative shock to investors aggregate asset demand. We consider a class of dynamic market settings where dealers can trade continuously with each other, while trading between dealers and investors is subject to delays and involves bargaining. We derive conditions on fundamentals, such as preferences, market structure and the characteristics of the market crash (e.g., severity, persistence) under which dealers provide liquidity to investors following the crash. We also characterize the conditions under which dealers incentives to provide liquidity are consistent with market efficiency.

Suggested Citation

Lagos, Ricardo and Rocheteau, Guillaume and Weill, Pierre-Olivier, Crashes and Recoveries in Illiquid Markets (June 2008). NBER Working Paper No. w14119, Available at SSRN: https://ssrn.com/abstract=1149365

Ricardo Lagos (Contact Author)

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Guillaume Rocheteau

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