Market run-ups, market freezes, inventories, and leverage
Abstract: This paper supersedes Working Paper No. 12-8.> We study trade between an informed seller and an uninformed buyer who have existing inventories of assets similar to those being traded. We show that these inventories may lead to prices that increase even absent changes in fundamentals (a .run-up.), but may also make trade impossible (a .freeze.) and hamper information dissemination. Competition may amplify the run-up by inducing buyers to enter loss-making trades at high prices to prevent a competitor from purchasing at a lower price and releasing bad news about inventory values. Inventories also prevent seller competition from delivering the Bertrand outcome, in which prices match sellers? valuations. We discuss both empirical implications and implications for regulatory intervention in illiquid markets.
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Provider: Federal Reserve Bank of Philadelphia
Part of Series: Working Papers
Publication Date: 2013