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Post by Sapphire Capital on Feb 16, 2009 21:24:38 GMT 4
Liquidity, Runs, and Security Design: Lessons from the Collapse of the Auction Rate Municipal Bond Market Song Han Federal Reserve Board - Division of Research and Statistics - Capital Markets Section Dan Li Federal Reserve Board - Division of Research and Statistics - Capital Markets Section January 15, 2008 Abstract: In this paper, we use the recent collapse of the ARS market as a case study on important issues regarding fragility of financial innovations and systemic risks. We find strong evidence of investor runs for liquidity, partly caused by a self-fulfilling panic. In addition, coordination failures triggered by an unexpected first mover led all major broker-dealers to simultaneously withdraw their liquidity support. We also find that the likelihood of auction failures and ARS reset rates depend significantly on both the rule and the level of maximum auction rates; that, as predicted by auction theories, there is also strong evidence for underpricing after dealers withdrew their liquidity supports; and that inter-auction secondary market liquidity may encourage aggressive bidding that increases the reset rates. papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1327308_code229077.pdf?abstractid=1325702&mirid=2
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