Illiquidity Comovement and Market Crisis

doi:10.1007/s11424-022-0299-1

Journal of Systems Science and Complexity ›› 2022, Vol. 35 ›› Issue (5): 1863-1874.DOI: 10.1007/s11424-022-0299-1

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Illiquidity Comovement and Market Crisis

ZENG Qingduo¹, ZHANG Qiang², LIU Shancun³, YANG Yaodong⁴

1. School of Economics and Commerce, Guangdong University of Technology, Guangzhou 510520, China;
2. School of Economics and Management, Beijing University of Chemical Technology, Beijing 100029, China;
3. School of Economics and Management, Beihang University, Beijing 100191, China;
4. Department of Computer Science, University College London, London, UK.

Received:2020-11-26 Revised:2021-06-06 Online:2022-10-25 Published:2022-10-12
Supported by:
This paper was supported by China Postdoctoral Science Foundation under Grant No.2019M660424,the National Natural Science Foundation of China under Grant Nos.71771008 and 71803029,Guangdong Province Philosophy and Social Science Planning Project under Grant No.GD21YYJ10.

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ZENG Qingduo, ZHANG Qiang, LIU Shancun, YANG Yaodong. Illiquidity Comovement and Market Crisis[J]. Journal of Systems Science and Complexity, 2022, 35(5): 1863-1874.

This paper presents a rational expectation equilibrium model to explore how the financial contagion occurs between the unlinked markets that do not share common fundamentals.In the proposed model,the authors assume two of the three risky assets share no common fundamental factors,but are connected by one intermediate asset via cross fundamentals.Through this channel,investors transmit fundamental risk from one asset to another by dint of the cross fundamentals.This mechanism causes liquidity comovement and subsequently becomes a source of market crisis:Through the contagion mechanism,an initial liquidity shock in one asset can result in a drop tendency in liquidity and price informativeness for another asset.Such comovement in liquidity offers a new explanation for idiosyncratic assets in financial contagion.

Key words: Contagion, crisis, illiquidity, rational expectation equilibrium

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