Paper #1003

Title:

On the impact of fundamentals, liquidity and coordination on market stability

Authors:

Francisco Peñaranda and Jón Daníelsson

Date:

January 2007 (Revised: March 2010)

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 amongst agents. We observe occasionally 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.

Keywords:

global games, efficient method of moments, carry trades, tail risk, strategic behavior, financial crises

JEL codes:

C13, C15, C22, C51, F31, G12, G15

Area of Research:

Finance and Accounting / Statistics, Econometrics and Quantitative Methods

Published in:

International Economic Review, 52, pp. 621-638, 2011.

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