A Theory of Endogenous Asset Fire Sales, Bank Runs, and Contagion

52 Pages Posted: 5 Sep 2017

See all articles by Zhao Li

Zhao Li

University of International Business and Economics (UIBE) - School of Banking and Finance

Kebin Ma

University of Warwick - Finance Group

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Date Written: September 3, 2017

Abstract

In a global-games framework, we endogenize asset fire sales, bank runs, and contagion by emphasizing a lack of information: investors can be uncertain whether banks selling assets to fend o runs are insolvent or simply illiquid. However, it is this uncertainty that leads to asset price collapses and runs in the first place. We show that a balanced-budget asset purchase program promotes financial stability by breaking down this vicious cycle. By contrast, increasing capital can exacerbate fire sales in the presence of adverse selection, because runs on well-capitalized banks signal high risks. We also derive implications regarding regulatory disclosure policies.

Keywords: Bank run, Global games, Asymmetric information, Capital, Asset purchase program

JEL Classification: G01, G11, G21

Suggested Citation

Li, Zhao and Ma, Kebin, A Theory of Endogenous Asset Fire Sales, Bank Runs, and Contagion (September 3, 2017). Available at SSRN: https://ssrn.com/abstract=3031642 or http://dx.doi.org/10.2139/ssrn.3031642

Zhao Li (Contact Author)

University of International Business and Economics (UIBE) - School of Banking and Finance ( email )

No.10, Huixindong Street
Chaoyang District
Beijing, 100029
China

Kebin Ma

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

HOME PAGE: http://www.kebinma.com

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