Fragility of Financial Markets

Fragility of financial markets arises when market prices exhibit amplified reaction to underlying shocks, either fundamental or nonfundamental. The history of financial markets features many examples of such episodes, market-wide or asset-specific, which have generally been of great concern. Using a canonical framework of trading in financial markets, we provide an overview of forces generating fragility. These forces include learning by investors from the price as they make trading decisions and various channels for strategic complementarities among investors that act against price-induced strategic substitutes. We analyze the informativeness and volatility of prices and how they are related to the fragility concept.