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Liquidity, information and coordination in financial markets.

Afonso, Gara Minguez (2008) Liquidity, information and coordination in financial markets. PhD thesis, London School of Economics and Political Science (United Kingdom).

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Abstract

No two crises are identical. As we learn from them, they evolve and change. This thesis is an attempt to understand some of their features. We discuss the abandonment of a peg (Chapter 2), full disruption of payments (Chapter 3) and illiquidity in one-sided markets (Chapter 4). Chapter 2 investigates the consequences of introducing uncertainty about the willingness of a central bank to defend the peg in an economy in which a government runs a persistent deficit. We analyze how not knowing when other arbitrageurs intend to attack a currency affects investors' decision to attack. Specifically, we show how the lack of common knowledge induces arbitrageurs to delay their attack on the currency, which in turn leads to a discrete devaluation of the exchange rate as it is generally observed during currency crises. In Chapter 3 we examine how financial integration of payment systems creates a feedback channel which might threaten the stability of financial markets. In payment systems, banks rely heavily on incoming transfers to finance outgoing payments requiring a high degree of coordination and synchronization. We study the response of the payment system to disruptions in payments and to changes in the precautionary demand for liquid balances targeted by the different institutions in a payment system. This work aims to shed light on the recent events in credit markets. The analysis of liquidity in one-sided markets is the focus of Chapter 4. When a market is in distress, liquidity typically vanishes playing a key role in the build-up of one-sided markets. We present an alternative view of market liquidity which results from a tradeoff between market externalities and a congestion effect. When congestion is the dominating effect, as during fire sales, diminishing market frictions can deteriorate liquidity and reduce welfare. Our results provide a rationale for circuit breakers.

Item Type: Thesis (PhD)
Uncontrolled Keywords: Economics, Finance
Sets: Collections > ProQuest Etheses
Departments > Finance
URI: http://etheses.lse.ac.uk/id/eprint/2960

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