Fire Sales Forensics: Measuring Endogenous Risk

37 Pages Posted: 4 May 2012 Last revised: 5 Feb 2013

See all articles by Rama Cont

Rama Cont

University of Oxford

Lakshithe Wagalath

IESEG School of Management

Date Written: May 4, 2012

Abstract

We propose a tractable framework for quantifying the impact of fire sales on the volatility and correlations of asset returns in a multi-asset setting. Our results enable to quantify the impact of fire sales on the covariance structure of asset returns and provide a quantitative explanation for spikes in volatility and correlations observed during liquidation of large portfolios. These results allow to estimate the impact and magnitude of fire sales from observation of market prices: we give conditions for the identifiability of model parameters from time series of asset prices, propose an estimator for the magnitude of fire sales in each asset class and study the consistency and large sample properties of the estimator. We illustrate our estimation methodology with two empirical examples: the hedge fund losses of August 2007 and the Great Deleveraging following the Lehman default.

Keywords: fire sales, endogenous risk, systemic risk, liquidity, financial econometrics, correlation, volatility

Suggested Citation

Cont, Rama and Wagalath, Lakshithe, Fire Sales Forensics: Measuring Endogenous Risk (May 4, 2012). Available at SSRN: https://ssrn.com/abstract=2051013 or http://dx.doi.org/10.2139/ssrn.2051013

Rama Cont (Contact Author)

University of Oxford ( email )

Mathematical Institute
Oxford, OX2 6GG
United Kingdom

HOME PAGE: http://www.maths.ox.ac.uk/people/rama.cont

Lakshithe Wagalath

IESEG School of Management ( email )

1 Parvis de la Défense
Paris, 92044
France

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