Leverage and Preemptive Selling of Financial Institutions
50 Pages Posted: 31 Oct 2009 Last revised: 3 Oct 2010
Date Written: October 1, 2010
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: Suggested Citation