Market Transparency and Fragility
CESifo, Munich, 2016
CESifo Working Paper No. 6279
We show that dealers’ limited market participation, coupled with an informational friction resulting from lack of market transparency, can make liquidity demand upward sloping, inducing strategic complementarities: traders demand more liquidity when the market becomes less liquid, fostering market illiquidity. This can generate instability with an initial dearth of liquidity degenerating into a liquidity rout (as in a ash crash). In a fully transparent market, liquidity is increasing in the proportion of dealers continuously present in the market; however, in a less transparent market, liquidity can be U-shaped in this proportion and in the degree of transparency.
Monetary Policy and International Finance
Empirical and Theoretical Methods