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FMG-1: Financial Crises
Hasty Deleverage and Liquidity Spiral: Evidence from Margin Trading of Individual Stocks (withdrawn)
A sudden stop on margin trading triggers a hasty deleverage and speedy crash on China stock market in summer 2015, which provides an almost natural experiment to study liquidity spiral in financial crises. We employ stock-level margin trading data to study the deleverage-illiquidity-return joint dynamics. Evidence reveals that 1) hasty deleverage simultaneously crashes stock prices and liquidity; 2) stocks under greater deleverage pressure are more likely to be stuck in liquidity shortage; and 3) liquidity shortage amplifies stock price declines. Speedy rebound after the crash suggests existence of overshooting. We also find evidence that liquidity dry-up is responsible for the overshooting.
Systematic Liquidity and Leverage
1University of Oxford; 2Yale University
Does trader leverage exacerbate the liquidity co-movement that we observe during crises? We exploit the threshold rules governing margin trading eligibility in India to identify a causal relationship between trader leverage and the extent to which a stock’s liquidity covaries with the liquidity of other stocks. We find that trader leverage causes sharp increases in comovement during severe market downturns. For our sample of stocks, the estimates suggest that the trader leverage channel explains about one third of the increase in liquidity commonality that we observe during crises. Consistent with downward price pressure due to the deleveraging of traders who rely on borrowing, we also find that leverage causes stocks to exhibit large increases in return comovement during crises.
Sovereign Risk and Bank Risk-Taking
University of Cambridge
I propose a general equilibrium macroeconomic model in which strategic interactions between banks and depositors may lead to endogenous bank fragility and default, associated with a persistent drop in investment and output. With some opacity in bank balance sheets, depositors form expectations about bank risk-taking and demand a return on bank deposits according to their risk. This creates strategic complimentarities and possibly multiple equilibria: in response to an increase in funding costs, banks may optimally choose to pursue risky portfolios that undermine their solvency prospects. I bring the model to bear on the European sovereign debt crisis, in the course of which under-capitalized banks in default-risky countries experienced an increase in funding costs and raised their holdings of domestic government debt. The model is quantified using Portuguese data and accounts for macroeconomic dynamics in Portugal in 2010-2016. Policy interventions face a trade-off between alleviating banks' funding conditions and strengthening risk-taking incentives. Liquidity provision to banks may eliminate the good equilibrium when not targeted. Targeted interventions have the capacity to eliminate adverse equilibria.
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Conference: EFA 2017
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