Inefficient Fire-Sales in Decentralized Asset Markets

Abstract

Classic models of fire-sales that emphasize liquidity-constrained natural buyers can-notfully account for the asset fire-sales during the Financial Crisis of 2008. I present a modelto demonstrate that fire-sales may happen even when there is a sizable pool of naturalbuyers and in the absence of asymmetric information, due to a coordina-tion failureamong buyers. In particular, I show that when trade is decentralized and participation isendogenous, constrained asset demand and liquidity needs that are ex-pected to increaseover time create complementarity among buyers' decisions to wait. This complementaritymakes competitive markets prone to coordination failures and fire-sales which may beinefficient. I also discuss various policy options to eliminate the risk of fire-sales in such asetup.

Keywords: Supply and demand, Asset prices, Financial assets, Balance sheets, Asset markets, fire-sales, coordination failure, decentralized markets, competitive search, fire-sale, run equilibrium, multiple equilibrium, asset market, asset price

JEL Classification: G01, G12, D61, D62, D83, H44, E44, E01, F16, D4, G