What should we fear in the coming months? Liquidity spirals are a thing and if we have markets that move to extremes, there is a greater likelihood of seeing one. A spiral is different from a bubble although the two can be related. If there are some initial loses, especially if positions are highly levered, there will be funding problems. The funding problems can be caused by higher margins or the requirement to add to margin for existing positions. See "When Everyone Runs for the Exists".
If there is some funding issue even as simple of movement of margin, positions will be reduced which will add to any existing losses. There is a positive feedback loop. Feedback loops drive trends, and these trends will create further liquidity issues. This will only get worse if there are crowded trades. The simple issue is that the microstructure of markets can create endogenous risks which generate liquidity spirals.
No comments:
Post a Comment