Rumors and Runs in Opaque Markets: Evidence from the Panic of 1907

Using a new daily dataset for all stocks traded on the New York Stock Exchange, we study the impact of information asymmetry during the liquidity freeze and market run of October 1907 - one of the most severe financial crises of the 20th century. We estimate that the run on the market increased spreads from 0.5% to 3% during the peak of the crisis and, using a spread decomposition, we also demonstrate that fears of informed trading account for most of that deterioration of liquidity. Information costs rose most in the mining sector - the origin of the panic rumors - and in other sectors with poor track records of corporate reporting. In addition to wider spreads and tight money markets, we find other hallmarks of information-based illiquidity: trading volume dropped and price impact rose. Importantly, despite short-term cash infusions into the market, we find that the market remained relatively illiquid for several months following the panic. We go on to show that rising illiquidity enters positively in the cross section of stock returns. Thus, our findings demonstrate how opaque markets can easily transmit an idiosyncratic rumor into a long-lasting, market-wide crisis. Our results also demonstrate the usefulness of illiquidity measures to alert market participants to impending market runs.