Fire Sales and Inside Information: When Insiders Help

Abstract:     
We study how inside information reduces the transmission of the crisis due to fire sales (e.g., Shleifer and Vishny, 2012). We focus on the role of international institutional investors in propagating financial market instability and the mediating role of the banking sector during the 2008-2009 global financial crisis. We argue that international institutional investors affiliated with banking conglomerates share information with the banks’ lending subsidiaries. This provides them with inside information that lowers their incentive to join uninformed fire sales as the crisis emerges. We test this intuition using a comprehensive data set on international mutual fund holdings over the period 2001-2009. We show that bank affiliation provides an informational advantage that more than offsets disadvantages due to geography. During the pre-crisis period, this inside information causes bank-affiliated funds to function as insiders, reducing the liquidity of the stocks they hold, and increasing extreme negative return realizations. However, during the crisis, bank-affiliated funds increase stock liquidity, reduce extreme negative return realizations, increase price informativeness, and reduce short-selling demand. Overall, during the crisis, bank-affiliated funds provide price support over the stocks they have inside information.

Number of Pages in PDF File: 53

Keywords: fire sales, crisis, bank-affiliation, foreign ownership, liquidity

JEL Classification: G10, G15, G21

working papers series