Fire Sales in Frozen Markets

May 6, 2019

Preview Citation

Format: Chicago

Ehsan Ebrahimy. Fire Sales in Frozen Markets, (USA: International Monetary Fund, 2019) accessed December 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

It is challenging to explain the collapse in the price of subprime mortgage-backed securities (MBS) during the Financial Crisis of 2008, using the existing models of fire-sale. I present a model to demonstrate that fire-sales may happen even when there is a relatively sizable pool of natural buyers and in the absence of asymmetric information, due to a coordination failure among buyers: buyers’ waiting to trade at a lower price tomorrow, can lead to a collapse in the price and trade volume today. In particular, I show that when trade is decentralized and participation is endogenous, a medium level of asset demand and liquidity needs that are ex-pected to increase over time create complementarity among buyers’ decisions to wait. This complementarity makes competitive markets prone to coordination failures and fire-sales accompanied by a collapse in the trade volume. Fire-sales may also be inefficient. I also discuss various policy options to eliminate the risk of fire-sales in such a setup.

Subject: Asset and liability management, Asset liquidity, Asset prices, Financial markets, Liquidity, Prices, Securities markets

Keywords: Asset liquidity, Asset market, Asset Markets1, Asset price, Asset prices, Decentralized asset Markets1, Equilibrium price, Fire-sale equilibrium, Inefficient fire-sale, Liquidity, Price impact, Securities markets, WP

Publication Details

Pages:

39
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2019/092
Stock No:

WPIEA2019092
ISBN:

9781498303804
ISSN:

1018-5941

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