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

52 Pages Posted: 4 Oct 2017

See all articles by Zhao Li

Zhao Li

Universitat Pompeu Fabra - Department of Economics and Business

Kebin Ma

University of Warwick - Finance Group

Multiple version iconThere are 3 versions of this paper

Date Written: March 15, 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 off 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 circle. By contrast, increased 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 (March 15, 2017). Paper presented at Conference on Systemic Risk and the Organization of the Financial System, Chapman University, May 13, 2017, Available at SSRN: https://ssrn.com/abstract=3047560 or http://dx.doi.org/10.2139/ssrn.3047560

Zhao Li

Universitat Pompeu Fabra - Department of Economics and Business ( email )

​C. Ramon Trias Fargas 25-27, 08005
Barcelona
Spain

HOME PAGE: http://zhaoli.org

Kebin Ma (Contact Author)

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

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

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