Fire Sales, Foreign Entry and Bank Liquidity

62 Pages Posted: 27 May 2008

See all articles by Viral V. Acharya

Viral V. Acharya

New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Hyun Song Shin

Bank for International Settlements (BIS)

Tanju Yorulmazer

University of Amsterdam - Faculty of Economics and Business (FEB)

Date Written: May 2007

Abstract

Bank liquidity is a crucial determinant of the severity of banking crises. In this paper, we consider the effect of fire sales and foreign entry on banks' ex ante choice of liquid asset holdings, and the ex post resolution of crises. In a setting with limited pledgeability of risky cash flows and differential expertise between banks and outsiders in employing banking assets, the market for assets clears only at fire-sale prices following the onset of a crisis - and outsiders may enter the market if prices fall sufficiently low. While fire sales make it attractive for banks to hold liquid assets, foreign entry reduces this incentive. We exhibit international evidence on foreign entry following crises and on banks' ex ante liquidity choice that are consistent with the predictions of the model. Our framework allows us to address the key welfare question as to when there is too much or too little liquidity on bank balance sheets relative to the socially optimal level.

Keywords: crises, distress, limited pledgeability, liquidation cost, systemic risk

JEL Classification: D61, E58, G21, G28, G32

Suggested Citation

Acharya, Viral V. and Shin, Hyun Song and Yorulmazer, Tanju, Fire Sales, Foreign Entry and Bank Liquidity (May 2007). , Vol. , pp. -, 2007. Available at SSRN: https://ssrn.com/abstract=1136616

Viral V. Acharya (Contact Author)

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Hyun Song Shin

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

Tanju Yorulmazer

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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