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Self-fulfilling liquidity dry-ups

By Fr\ue9d\ue9ric Malherbe

Abstract

Secondary markets for long-term assets might be illiquid due to adverse selection. In a model in which moral hazard is confined to project initiation, I find that: (1) when agents expect a liquidity dry-up on such markets, they optimally choose to self-insure through the hoarding of non-productive but liquid assets; (2) such a response has negative externalities as it reduces ex-post market participation, which worsens adverse selection and dries up market liquidity; (3) liquidity dry-ups are Pareto inefficient equilibria; (4) the Government can rule them out. Additionally, when agents face idiosyncratic, privately known, illiquidity shocks, I show that: (5) it increases market liquidity; (6) illiquid agents are better-off when they can credibly disclose their liquidity position, but transparency has an ambiguous effect on risk-sharing possibilities

Topics: E44, G01, G11, ddc:330, Liquidity, Liquidity Dry-ups, Financial Crises, Hoarding, Adverse Selection, Self-insurance, Portfolio-Management, Marktliquidit\ue4t, Schock, Adverse Selektion, Finanzkrise, Anlegerschutz, Second Best, Theorie
Publisher: Brussels: National Bank of Belgium
Year: 2010
OAI identifier: oai:econstor.eu:10419/144397
Provided by: EconStor

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