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Liquidity and Liquidation

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  • Kelly, David
  • LeRoy, Stephen F.

Abstract

The manager of a firm that is selling an illiquid asset has discretion as to the sale price: if he chooses a high (low) selling price, early sale is unlikely (likely). If the manager has the option to default on the debt that is collaterized by the illiquid asset, the optimal selling price depends on whether the manager acts in the interest of the owners or the creditors. We model the former case. In the preferred equilibrium, the owner will always offer the illiquid asset for sale at a strictly higher price than he paid, and he will always default if he fails to sell. As a result, the illiquid asset changes hands at successively higher prices; the price inflation terminates upon the first failure to sell, which results in a default chain.

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Bibliographic Info

Paper provided by Department of Economics, UC Santa Barbara in its series University of California at Santa Barbara, Economics Working Paper Series with number qt4fq7n6pj.

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Date of creation: 07 Dec 2001
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Handle: RePEc:cdl:ucsbec:qt4fq7n6pj

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Keywords: Liquidity; Liquidation;

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References

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  1. John G. Riley & Richard Zeckhauser, 1980. "Optimal Selling Strategies:," UCLA Economics Working Papers 180, UCLA Department of Economics.
  2. Haugen, Robert A & Senbet, Lemma W, 1978. "The Insignificance of Bankruptcy Costs to the Theory of Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 33(2), pages 383-93, May.
  3. Milgrom, P. & Shannon, C., 1991. "Monotone Comparative Statics," Papers 11, Stanford - Institute for Thoretical Economics.
  4. Krainer, John, 2001. "A Theory of Liquidity in Residential Real Estate Markets," Journal of Urban Economics, Elsevier, vol. 49(1), pages 32-53, January.
  5. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
  6. Ko Wang & Leslie Young & Yuqing Zhou, 2002. "Nondiscriminating Foreclosure and Voluntary Liquidating Costs," Review of Financial Studies, Society for Financial Studies, vol. 15(3), pages 959-985.
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Cited by:
  1. John Krainer & Mark Spiegel & Nobuyoshi Yamori, 2005. "Asset price declines and real estate market illiquidity: evidence from Japanese land values," Working Paper Series 2004-16, Federal Reserve Bank of San Francisco.
  2. David L. Kelly & Stephen F. LeRoy, 2005. "Liquidity and fire sales," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 249-270.

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