Financial Contagion and Market Liquidity: Evidence from the Asian Crisis

The IUP Journal of Applied Finance, Vol. 17, No. 3, pp. 5-33, July 2011

Posted: 17 May 2012

See all articles by Rupendra Paliwal

Rupendra Paliwal

John F. Welch College of Business, Sacred Heart University

Shantaram P. Hegde

University of Connecticut- Finance Department

Date Written: May 17, 2012

Abstract

Models of financial crisis and contagion predict that an economic crisis turns into a crisis of market liquidity in the presence of borrowing constraints, information asymmetry and risk aversion. Based on the firm-level data on a sample of exposed and unexposed US stocks to the Asian currency crisis, we find a significant increase (decrease) in the crisis period bid-ask spreads (depth) and their volatilities for both the groups. While our results underscore the imprints of flight to quality, we detect little causal patterns in liquidity innovations. An important implication of our findings, as evidenced by the recent crisis, is that regulatory response to enhance liquidity during a crisis should not be limited to the industries and markets directly exposed to the crisis. Finally, we find that the deterioration in market liquidity provides a partial explanation for the crisis-induced abnormal returns.

Suggested Citation

Paliwal, Rupendra and Hegde, Shantaram P., Financial Contagion and Market Liquidity: Evidence from the Asian Crisis (May 17, 2012). The IUP Journal of Applied Finance, Vol. 17, No. 3, pp. 5-33, July 2011, Available at SSRN: https://ssrn.com/abstract=2061494

Rupendra Paliwal (Contact Author)

John F. Welch College of Business, Sacred Heart University ( email )

5151 Park Avenue
Fairfield, CT 06432
United States
203-371-7851 (Phone)

HOME PAGE: http://business.sacredheart.edu/

Shantaram P. Hegde

University of Connecticut- Finance Department ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States
860-486-5135 (Phone)

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