Liquidity Crises in Opaque Markets: The NYSE in the Panic of 1907

We study the Panic of 1907 to understand how opaque corporate governance and loose market regulation can render financial systems susceptible to financial crises. Using a new daily dataset for all stocks traded on the New York Stock Exchange between 1905 and 1910, we study the impact of information asymmetry during the Panic of 1907- one of the most severe financial crises of the 20th century. We estimate that the acute liquidity freeze drove up the median spread from 0.8% to 3% during the peak of the crisis in October of that year. Spreads rose most among mining companies-the industry with the worst track record of corporate governance and the epicenter of the rumors that triggered runs on several financial institutions with links to a notorious firm in the sector. Stocks of the highly-regulated railroad firms and companies with close ties to Wall Street’s “Money Trust” weathered the crisis with the greatest trading liquidity. We find other hallmarks of information-based illiquidity: trading volume dropped and price impact rose. Despite short-term cash infusions into the market, the market remained relatively illiquid for several months following the peak of the panic. Thus, our findings demonstrate how opaque systems allow idiosyncratic rumors to spread and amplify into a long-lasting, market-wide crisis. Asset pricing tests suggest that sophisticated traders recognized and incorporated liquidity considerations in their pricing of market risk.