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LIQUIDITY CASCADES
THE COORDINATED RISK OF UNCOORDINATED MARKET PARTICIPANTS

A central property of a complex system is the possible occurrence of coherent large-scale collective behaviors with a very rich structure, resulting from the repeated non-linear interactions among its constituents: the whole turns out to be much more than the sum of its parts.

— Didier Sornette

OVERVIEW

Within we dive into the circumstantial evidence surrounding the “weird” behavior many investors believe markets are exhibiting. We tackle narratives such as the impact of central bank intervention, the growing scale of passive / indexed investing, and asymmetric liquidity provisioning.

Spoiler: Individually, the evidence for these narratives may be nothing more than circumstantial. In conjunction, however, they share pro-cyclical patterns that put pressure upon the same latent risk: liquidity.

In the last part of the paper we discuss some ideas for how investors might try to build portfolios that can both seek to exploit these dynamics as well as remain resilient to them.