Persistent noise, investors’ expectations, and market meltdowns

Giovanni Cespa, Xavier Vives 22 April 2014

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The recent financial crisis has revived interest in the question of what triggers crashes and meltdowns in financial markets. An important reason for abrupt and large price dislocations is the lack or ‘slow motion’ of arbitrage capital (Duffie 2010) that weakens the risk-bearing capacity of liquidity providers.

We suggest that there is an alternative explanation based on expectations dynamics in the presence of persistent market noise.

In the market:

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Topics:  Financial markets

Tags:  liquidity, financial crises, asset prices, noise trading, informational efficiency

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