Anatomy of a Market Crash: A Market Microstructure Analysis of the Turkish Overnight Liquidity Crisis

Abstract

An order flow model, where the coded identity of the counterparties of every trade is known, (providing institutional order flow) is applied to both stable and crisis periods in a large and liquid overnight repo market in an emerging market economy. Institutional level order flow is much more informative than cross sectionally aggregated order flow. The informativeness of order flow increases with financial instability. Traders place greater emphasis on measuring the trading activities of their competitors when markets are more volatile, enabling them to identity potential targets for squeezing, especially during the crisis when several banks are vulnerable.

Measuring and Explaining Liquidity on an Electronic Limit Order Book: Evidence from Reuters D2000-2

“…On a theoretical level, it argues that most of the observed results are consistent with asymmetric information theories. Daníelsson and Saltoglu (2002) take advantage of the insights of Daníelsson and Payne (2002a) in their analysis of the recent Turkish financial crises, and find that market microstructure liquidity patterns played a key role in the evolution of the crises.…”

Investigating risk contagion initiated by endogenous liquidity shocks: evidence from the US and eurozone interbank markets

“…Others analyse the behaviour and effects of market fundamentals in periods of financial turmoil (Kaminsky and Reinhart, 2000). Market microstructure models attempt to describe the role of information and its relationship to price discovery during financial crises (Hartmann et al, 2001;Daníelsson and Saltoglu, 2003), whereas spillover effects are primarily investigated via correlation techniques (Baba et al, 2008;Frank et al, 2008;Gorton and Metrick, 2012). The weakness of these models is that these do not explain what exactly drives volatile time periods, neither how liquidity risk propagates within the interbank market.…”

“…2 Daníelsson and Saltoglu (2003) suggest the term 'endogenous risk' as being the one generated and intensified from inside the financial system. To further clarify the terminology, in our setup endogeneity does not imply that some independent variable is correlated with the error term.…”

Liquidity Risk Contagion in the Interbank Market

“…2 Some argue that empirical market microstructure provides a foundation for investigating price development and informational relationships in financial markets, which is paramount in describing and understanding financial crises. Daníelsson and Saltoglu (2003) investigate the short-lived liquidity crisis of December 2000 which struck the Turkish overnight market and show that an institutional level order flow model provides an insight and detailed explanation of decision making in an elaborate way. Hartmann et al (2001) investigate the microstructure of the overnight Euro money market, specifically looking at monetary policy changes and their effect on intra-day trading patterns.…”