nep-mst New Economics Papers
on Market Microstructure
Issue of 2021‒09‒13
one paper chosen by
Thanos Verousis

  1. Market Freezes By Chao Gu; Guido Menzio; Randall Wright; Yu Zhu

  1. By: Chao Gu; Guido Menzio; Randall Wright; Yu Zhu
    Abstract: During the financial crisis apparently centralized markets continued to function while trade in OTC markets froze. We use search-and-bargaining theory to ascertain conditions that allow trade to temporarily freeze in decentralized markets, focusing on the roles of liquidity and self-fulfilling prophecies. We show standard models can have recurrent, belief-driven hot and cold spells, but not freezes and thaws. A simple specification that has freezes assumes negative returns. A more realistic one incorporates information frictions (costly asset-quality verification). Another uses different frictions to get credit freezes. We also discuss policy implications, and go into detail on the nature of OTC markets.
    JEL: D53 D83 E30 E44 E52 G14
    Date: 2021–09

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