ON THE IMPACT OF FUNDAMENTALS, LIQUIDITY, AND COORDINATION ON MARKET STABILITY

Authors

  • Jón Daníelsson,

    1. London School of Economics, U.K.; Universitat Pompeu Fabra, Spain
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  • Francisco Peñaranda

    1. London School of Economics, U.K.; Universitat Pompeu Fabra, Spain
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    • We would like to thank Irma Clots–Figueras, Amil Dasgupta, Antonio Díez, Ron Gallant, Masazumi Hattori, Frank Heinemann, Ángel León, Guillaume Plantin, Enrique Sentana, Hyun Shin, and two anonymous referees for very useful comments and suggestions. Daníelsson acknowledges the financial support of the EPSRC Grant No. GR/S83975/01 and Peñaranda the support of the MEC Grants SEJ2005-02829/ECON and ECO2008-03066, the Barcelona GSE, and the Government of Catalonia. Our papers can be downloaded from http://www.RiskResearch.org. Please address correspondence to: Jón Daníelsson, Department of Finance, London School of Economics, Houghton Street, London WC2A 2AE, U.K. Phone: +44 (0)20 7955 6056. Fax: +44 (0)20 7849 4647. E-mail: j.danielsson@lse.ac.uk


  • Manuscript received April 2008; revised July 2009.

Abstract

We develop a coordination game to model interactions between fundamentals and liquidity during unstable periods in financial markets. We then propose a flexible econometric framework for estimation of the model and analysis of its quantitative implications. The specific empirical application is carry trades in the yen–dollar market, including the turmoil of 1998. We find a generally very deep market, with low information disparities among agents. We observe occasional episodes of market fragility or turmoil with up by the escalator, down by the elevator patterns in prices. The key role of strategic behavior in the econometric model is also confirmed.

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