Fire-Sales in Frozen Markets

45 Pages Posted: 5 Nov 2020

See all articles by Ehsan Ebrahimy

Ehsan Ebrahimy

International Monetary Fund (IMF)

Date Written: September, 2019

Abstract

It is challenging to explain the collapse in the price of subprime mortgage-backed securities (MBS) during the Financial Crisis of 2008, using the existing models of fire sale. I present a model to demonstrate that fire sales may happen even when there is a relatively sizable pool of natural buyers and in the absence of asymmetric information, due to a coordination failure among buyers: buyers’ waiting to trade at a lower price tomorrow, can lead to a collapse in the price and trade volume today. In particular, I show that when trade is decentralized and participation is endogenous, a medium level of asset demand and liquidity needs that are expected to increase over time create complementarity among buyers’ decisions to wait. This complementarity makes competitive markets prone to coordination failures and fire sales accompanied by a collapse in the trade volume. Fire sales may also be inefficient. I also discuss various policy options to eliminate the risk of fire sales in such a setup.

Keywords: competitive search, coordination failure, decentralized markets, fire-sales

JEL Classification: G01, G12, D61, D62, D83, E44

Suggested Citation

Ebrahimy, Ehsan, Fire-Sales in Frozen Markets (September, 2019). ESRB: Working Paper Series No. 2019/100, Available at SSRN: https://ssrn.com/abstract=3723436 or http://dx.doi.org/10.2139/ssrn.3723436

Ehsan Ebrahimy (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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