Forced Portfolio Liquidation
AbstractWe study the problem of a leveraged investor that is forced to unwind a significant fraction of its portfolio in a collection of illiquid markets. It is shown that markets may become disrupted in response to a relatively small liquidity shock. As a consequence, the probability of default can be much higher than suggested by standard risk measures. We also study the impact of successful liquidation on relative asset prices. Our analysis suggests that effective risk management of leveraged financial entities should focus on the entity's potential to generate emergency cash-flows net of third-party claims for liquidity.
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Bibliographic InfoPaper provided by Banque de France in its series Working papers with number 179.
Length: 33 pages
Date of creation: 2007
Date of revision:
Portfolio liquidation ; Market disruption ; Leverage ; Determinants of asset liquidity ; Hedge funds ; Structured credit.;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
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