Coordination Game And Financial Crisis

After the funding liquidity in the financial market is shocked, manyfinancial institutes would sell assets or loan on asset to rollover their debtsto mature in recent. The behavior of financial institutes would bring downthe return of the assets. Short-run investors could observe biasedinformation about the decreasing in return and decide whether to hold orsell the asset. It studies the problem by building a global game modelbased on the coordination game to analyze the investors’ strategy, and thecomparative static analysis of the Nash equilibrium shows that if the assethas lower liquidity or is hold more by the short-run investors, then theinvestors are more likely to sell and the return of the asset during the crisiswould be lower. In the empirical part of the paper, it exploits the LehmanBrothers bankruptcy as a shock to reduce the funding liquidity of themarket, so the short-run investor would face the problem as the game inthe model. Then it tests the effectiveness of the model prediction in thiscase. All empirical methods used here show that the stocks with lowerliquidity would suffer larger return decrease during the period near thebankruptcy. The result of empirical part is robust and is consistent with theconclusion of theoretical model. The investors near the bankruptcy wouldconsider the pre-liquidity of the stocks and adjust their investment strategy，it results the stocks with lower liquidity would suffer larger abnormalreturn decrease near the bankruptcy than the stocks with higher liquidity. So the lower liquidity asset would be influenced larger than the higherliquidity asset during the shock, thus the regulation of financial market inChina should take the liquidity into consideration to reduce the probabilityof crisis and the bad effects of shock from other countries.