||Liquidity black hole and optimal behavioural model: an applied case
||Gianluca Marcato and Giovanni Tira
||In turmoil periods, market liquidity can experience sudden dry ups connected with significant price movements. This unexpected change in liquidity patterns, often driven by irrational investors’ behavior, is normally defined as Liquidity Black Hole (LBH). So far relevant research in this area explored macro-market level interactions rather than micro-agent decision making processes. In this study we show - both theoretically and empirically - that the LBH effect at market micro-level is originated by agents’ decisions made at mutual fund level. We present a model of investors’ behavior based on heterogenous expectations of market risk and return. The causes of a LBH are analyzed and the model is also applied to a specific mutual fund setting where leverage is allowed, but shortening the asset is forbidden (i.e. real estate mutual funds). Price creation is modeled both endogenously and exogenously. We show that the relationship between fund flows and expected liquidity risk follows an exponential function. Finally, we demonstrate that areas of absolute LBH exist and cannot be hedged. In those areas neither the available “cashlike cushion” nor the managerial skills of the market maker can avoid the “economic failure” of a fund.
|Year of publication:
Gianluca Marcato and Giovanni Tira (2012).
Liquidity black hole and optimal behavioural model: an applied case. 19th Annual European Real Estate Society Conference in Edinburgh, Scotland,