Essays on liquidity under-supply and emerging market bond closures

My dissertation consists of two essays. The subject of the fist one is liquidity. Emerging and mature economies have experienced repeated liquidity crises. A long-standing problem in economics is to understand what causes liquidity under-supply in equilibrium. We show that very little is needed to create liquidity under-supply in equilibrium: the presence of credit constraints on demand is sufficient. Moreover, the liquidity under-supply is a non-monotone function of the credit constraint. Thinking of credit constraints as the degree of financial development in the economy, our second result suggests that when financial markets are very undeveloped, as in some emerging markets, financial innovation may paradoxically make government intervention more necessary. Finally, we show that the liquidity under-supply can be very serious. When we make credit constraints endogenous the magnitude of the under-supply can be larger due to a liquidity under-supply multiplier.; The second essay studies closures in primary markets of Emerging Market bonds stressing the supply (investor) side of the problem. I use daily data on issuance and spreads covering the period 1997-2002 and present three stylized facts. First, Emerging Markets and High Yield exhibit higher price correlation around primary emerging market closures. Second, although Emerging Market spreads increase around primary market closures, the behavior across the credit spectrum within the asset class is not the same: high-rated Emerging Market spreads increase less than low-rated Emerging Market spreads. Third, during closures the drop in issuance is not uniform: high-rated Emerging Market issuance drops more than low-rated Emerging Market issuance. I build a multi-period general equilibrium model with incomplete markets and collateral based on Geanakoplos (2003). The first main result is that when rational heterogeneous crossover investors face a liquidity shortage, assets that have independent fundamentals may display correlated price behavior (explaining Fact 1). The second result shows that during liquidity shortages high margin asset prices fall more than low margin asset prices (explaining Fact 2). The third result shows that an investor liquidity shortage leads to a severe drop in the issuance, in particular that of the good Emerging Market asset, when there is adverse selection (explaining closures and Fact 3).