Fire Sale Risk and Credit

Abstract

This paper examines whether the risk of future collateral fire sales affects lending decisions. We study US mortgage applications and exploit exogenous variation in foreclosure frictions for identification. We find that lenders are less likely to approve mortgages when anticipated losses due to uncoordinated collateral liquidations are high, and when there is elevated risk of joint collateral liquidation. As expected, these results are stronger when fire-sale risk is more salient. The results suggest that fire-sale risk has implications for credit allocation, and that lenders’ collective (ex-ante) origination decisions mitigate fire-sale exposures ex-post.

Keywords: fire sales, credit supply, foreclosure laws, creditor concentration, joint liquidation risk, collateral

JEL Classification: G01, G21, G28, G33