Leverage and Preemptive Selling of Financial Institutions

50 Pages Posted: 31 Oct 2009 Last revised: 3 Oct 2010

See all articles by Antonio E. Bernardo

Antonio E. Bernardo

University of California, Los Angeles (UCLA) - Finance Area

Ivo Welch

University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)

Date Written: October 1, 2010

Abstract

In our model, financial firms’ leverage choices and asset sales impose externalities on other financial firms. This means that individual firms cannot determine their optimal capitalizations in isolation, but have to take the aggregate financial sector characteristics into account. They become more aggressive when their peers are more conservative. For large parameter regions, small parameter differences induce just mild differences in the equilibrium allocation of risk. However, going just a little further, they can also induce completely different equilibria. Historical experience is not necessarily a good guide as to whether the prevailing equilibrium is fragile or not.

Keywords: Leverage, Banks, Financial Institutions, Preemptive Selling, Fire Sales

JEL Classification: G2, G31

Suggested Citation

Bernardo, Antonio E. and Welch, Ivo, Leverage and Preemptive Selling of Financial Institutions (October 1, 2010). AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1497026 or http://dx.doi.org/10.2139/ssrn.1497026

Antonio E. Bernardo

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-2198 (Phone)
310-206-5455 (Fax)

Ivo Welch (Contact Author)

University of California, Los Angeles (UCLA) ( email )

110 Westwood Plaza
C519
Los Angeles, CA 90095-1481
United States
310-825-2508 (Phone)

HOME PAGE: http://www.ivo-welch.info

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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