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Forced Portfolio Liquidation

Author

Listed:
  • Ewerhart, C.
  • Valla, N.

Abstract

We 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.

Suggested Citation

  • Ewerhart, C. & Valla, N., 2007. "Forced Portfolio Liquidation," Working papers 179, Banque de France.
    • Handle: RePEc:bfr:banfra:179
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    References listed on IDEAS

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    Cited by:

    1. Legroux, Vincent & Rahmouni-Rousseau, Imène & Szczerbowicz, Urszula & Valla, Natacha, 2022. "Stabilising virtues of central banks: (Re)matching bank liquidity," Journal of Banking & Finance, Elsevier, vol. 134(C).
    2. van Achter, Mark, 2008. "Dynamic limit order market with diversity in trading horizons," CFS Working Paper Series 2008/46, Center for Financial Studies (CFS).

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    More about this item

    Keywords

    Portfolio liquidation ; Market disruption ; Leverage ; Determinants of asset liquidity ; Hedge funds ; Structured credit.;
    All these keywords.

    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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