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Liquidity Formation and Preopening Periods in Financial Markets
Author(s) -
Hong Jieying,
Pouget Sébastien
Publication year - 2021
Publication title -
economica
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.532
H-Index - 65
eISSN - 1468-0335
pISSN - 0013-0427
DOI - 10.1111/ecca.12366
Subject(s) - market liquidity , adverse selection , liquidity risk , insider , monetary economics , welfare , financial market , liquidity crisis , portfolio , business , asset (computer security) , accounting liquidity , information asymmetry , economics , financial system , finance , market economy , computer security , law , political science , computer science
This paper studies the role of preopening periods in liquidity formation and welfare in financial markets. Because no transaction occurs during these preopening periods, their economic significance could be questioned. We model a market where costly participation and asymmetric information prevent latent liquidity from being expressed. At equilibrium, risk‐averse insiders use preopening periods to better coordinate supply and demand of liquidity by communicating liquidity needs, thus improving welfare. Partial or full communication of private signals by the insider with the asset at preopening periods does not always enhance liquidity formation, but improves welfare through reducing adverse selection risk faced by the outsider, and increasing the likelihood of her entry. Our findings have implications for portfolio management and the design of financial markets.