Daily Academic Alpha: Market Panics

Rumors and Runs in Opaque Markets: Evidence from the Panic of 1907

Using a new daily dataset for all stocks traded on the New York Stock Exchange, we study the impact of information asymmetry during the liquidity freeze and market run of October 1907 – one of the most severe financial crises of the 20th century. We estimate that the run on the market increased spreads from 0.5% to 3% during the peak of the crisis and, using a spread decomposition, we also demonstrate that fears of informed trading account for most of that deterioration of liquidity. Information costs rose most in the mining sector – the origin of the panic rumors – and in other sectors with poor track records of corporate reporting. In addition to wider spreads and tight money markets, we find other hallmarks of information-based illiquidity: trading volume dropped and price impact rose. Importantly, despite short-term cash infusions into the market, we find that the market remained relatively illiquid for several months following the panic. We go on to show that rising illiquidity enters positively in the cross section of stock returns. Thus, our findings demonstrate how opaque markets can easily transmit an idiosyncratic rumor into a long-lasting, market-wide crisis. Our results also demonstrate the usefulness of illiquidity measures to alert market participants to impending market runs.

Risky Business: Popular Images and Reality of Capital Markets Handling Risk – From the Tulip Craze to the Decade of Greed

Speculators are often portrayed in literature, film and the media as evil businessmen who prey upon markets. Or they are portrayed as fools, who art with their money. The popular portraits accepted by the culture, while colorful, are ill-informed.

This article looks at the view held of speculators in early bubbles such as Tulip Mania and the South Sea Bubble. It then moves to the 1780s and early 1790s in the United States and looks at the broadsides fired at speculators in Revolutionary War debt by supporters of Jefferson and Madison. Next, the Gilded Age exemplified by Jim Fisk (the great drummer and war profiteer), Daniel Drew (the Speculative Director), Jay Gould (the Dark Genius of Wall Street), and Commodore Vanderbilt (“the public be damned”) is surveyed. The article concludes its survey with the Decade of Greed, the 1980s, as seen through “Other People’s Money” and “Wall Street.”

While the portraits of these culprits are vivid and the fulminations and exhortations against speculation are entertaining, the historic and economic reality is much different. Speculators provide an important and discrete function. They provide capital and liquidity, risk taking, and rationing of resources vital for all market economies.

Is Housing Overvalued?

This paper examines whether it costs more to own a home or to rent. We argue this is a useful criterion for assessing housing overvaluation. We use a new Australian dataset, which includes prices and rents for matched properties, letting us value housing in levels. We find that if real house prices grow at their historical average pace, then owning a home is about as expensive as renting. If prices grow more slowly, as some forecasters predict, the framework used in this paper suggests that the average home buyer would be financially better off renting. We decompose house prices into contributions from rents, interest rates and expected capital gains, which may help policymakers in the detection of housing bubbles. Recent data do not show signs of a bubble.