Thin equity markets cannot accommodate temporary bulges of buy or sell orders without large price movements. The resulting volatility can induce risk-averse transactors who face transaction costs to desert these markets. Thus thinness and the related price volatility may become joint self-perpetuating features of an equity market, irrespective of the volatility of asset fundamentals. If, however, appropriate incentive schemes are adopted to encourage entry by additional investors, this vicious circle can be broken, eventually shifting the market to a self-sustaining, superior equilibrium characterized by a higher number of transactors, lower price volatility and larger supply of the asset.

Since the depth and liquidity of a market depend on the entry decisions of all potential participants, each trader assesses them according to conjectures about entry by others. If trade is equally costly across markets, this externality leads to the concentration of trade on one market. If not, it can produce multiple conjectural equilibria, some where trade concentrates on one market and others where large traders resort to a separate market or to search for a trading partner. While fragmentation is welfare-reducing in the two-market case, no such ranking is possible if it involves off-exchange search.

An arbitrageur with short investment horizon gains from accelerating price discovery by advertising his private information. However, advertising many assets may overload investors’ attention, reducing the number of informed traders per asset, and slowing price discovery. So the arbitrageur optimally concentrates advertising on just a few assets, unless his trades have significant price impact. The arbitrageur’s gain from advertising is increasing in the assets’ mispricing and in the precision of his private information, and is decreasing in its complexity. If several arbitrageurs have private information, inefficient equilibria can arise, where substantial mispricing persists or investors’ attention is overloaded.

[We present a model in which issuers of asset-backed securities choose to release coarse information to enhance the liquidity of their primary market, at the cost of reducing secondary market liquidity. The degree of transparency is inefficiently low if the social value of secondary market liquidity exceeds its private value. We show that various types of public intervention (mandatory transparency standards, provision of liquidity to distressed banks, or secondary market price support) have quite different welfare implications. Finally, we extend the model by endogenizing the private and social value of liquidity and the proportion of sophisticated investors.]

The underpricing of initial public offerings (IPOs) is generally explained with asymmetric information and risk. We complement these traditional explanations with a new theory where investors worry also about the after-market illiquidity that may result from asymmetric information after the IPO. The less liquid the aftermarket is expected to be, and the less predictable its liquidity, the larger will be the IPO underpricing. Our model blends such liquidity concerns with adverse selection and risk as motives for underpricing. The model's predictions are supported by evidence for 337 British IPOs effected between 1998 and 2000. Using various measures of liquidity, we find that expected after-market liquidity and liquidity risk are important determinants of IPO underpricing.

We study a model where some investors (“hedgers”) are bad at information processing, while others (“speculators”) have superior information-processing ability and trade purely to exploit it. The disclosure of financial information induces a trade externality: if speculators refrain from trading, hedgers do the same, depressing the asset price. Market transparency reinforces this mechanism, by making speculators’ trades more visible to hedgers. Hence, issuers will oppose both the disclosure of fundamentals and trading transparency. Issuers may either under- or over-provide information compared to the socially efficient level if speculators have more bargaining power than hedgers, while they never under-provide it otherwise. When hedgers have low financial literacy, forbidding their access to the market may be socially efficient.

The excess sensitivity of consumption to current income fluctuations is higher in countries where consumers borrow less. Low levels of consumer debt can result either from capital market imperfections or from a low demand for loans. The evidence suggests that the former view is more appropriate than the latter, and thus supports the hypothesis that excess sensitivity may be attributed to liquidity constraints, rather than to other factors.

Using novel monthly data for 226 euro-area banks from 2007 to 2015, we investigate the determinants of banks’ sovereign exposures and their effects on lending during and after the crisis. Public, bailed-out and poorly capitalized banks responded to sovereign stress by purchasing domestic public debt more than other banks, consistent with both the “moral suasion” and the “carry trade” hypothesis. Public banks’ purchases grew especially in coincidence with the largest ECB liquidity injections, which therefore reinforced the “moral suasion” mechanism. Bank exposures significantly amplified the impact of sovereign stress on bank lending to domestic firms, as well as on lending by foreign subsidiaries of stressed-country banks to firms in non-stressed countries. Altogether, our evidence connects this amplification effect and its cross-border transmission to the moral suasion exerted by domestic governments on banks during the crisis.

If banks have an informational monopoly about their clients, borrowers may curtail their effort level for fear of being exploited via high interest rates in the future. Banks can correct this incentive problem by committing to share private information with other lenders. The fiercer competition triggered by information sharing lowers future interest rates and future profits of banks. But, provided banks retain an initial informational advantage, their current profits are raised by the borrowers’ higher effort. This trade-off determines the banks’ willingness to share information. Their decision affects credit market competition, interest rates, volume of lending, and social welfare.