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Predatory Trading

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  • Brunnermeier, Markus K
  • Pedersen, Lasse Heje

Abstract

This Paper studies predatory trading: trading that induces and/or exploits other investors’ need to reduce their positions. We show that if one trader needs to sell, others also sell and subsequently buy back the asset. This leads to price overshooting and a reduced liquidation value for the distressed trader. Hence, the market is illiquid when liquidity is most needed. Further, a trader profits from triggering another trader’s crisis, and the crisis can spill over across traders and across markets.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4639.

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Date of creation: Sep 2004
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Handle: RePEc:cpr:ceprdp:4639

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Related research

Keywords: dealer exit stress test; liquidity; liquidity crisis; predation; risk management; systemic risk; valuation;

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References

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  1. Hyun Song Shin & Stephen Morris, 2004. "Liquidity Black Holes," Econometric Society 2004 North American Winter Meetings 620, Econometric Society.
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  7. Viral V. Acharya & Lasse Heje Pedersen, 2004. "Asset Pricing with Liquidity Risk," NBER Working Papers 10814, National Bureau of Economic Research, Inc.
  8. Martin D.D. Evans, H. Henry Cao, Richard K. Lyons, 2003. "Inventory Information," Working Papers gueconwpa~03-03-33, Georgetown University, Department of Economics.
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  10. Scholes, Myron S, 1972. "The Market for Securities: Substitution versus Price Pressure and the Effects of Information on Share Prices," The Journal of Business, University of Chicago Press, vol. 45(2), pages 179-211, April.
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  12. Madrigal, Vicente, 1996. " Non-fundamental Speculation," Journal of Finance, American Finance Association, vol. 51(2), pages 553-78, June.
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  15. Dimitri Vayanos, 2001. "Strategic trading in a dynamic noisy market," LSE Research Online Documents on Economics 447, London School of Economics and Political Science, LSE Library.
  16. Allen, Franklin & Gale, Douglas, 1992. "Stock-Price Manipulation," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 503-29.
  17. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2005. "Over-the-Counter Markets," Econometrica, Econometric Society, vol. 73(6), pages 1815-1847, November.
  18. Grossman, S.J. & Miller, M.H., 1988. "Liquidity And Market Structure," Papers 88, Princeton, Department of Economics - Financial Research Center.
  19. Longstaff, Francis A, 2001. "Optimal Portfolio Choice and the Valuation of Illiquid Securities," Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 407-31.
  20. Jarrow, Robert A., 1992. "Market Manipulation, Bubbles, Corners, and Short Squeezes," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(03), pages 311-336, September.
  21. Hart, Oliver D & Kreps, David M, 1986. "Price Destabilizing Speculation," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 927-52, October.
  22. Shleifer, Andrei, 1986. " Do Demand Curves for Stocks Slope Down?," Journal of Finance, American Finance Association, vol. 41(3), pages 579-90, July.
  23. Albert S. Kyle, 2001. "Contagion as a Wealth Effect," Journal of Finance, American Finance Association, vol. 56(4), pages 1401-1440, 08.
  24. Bolton, Patrick & Scharfstein, David S, 1990. "A Theory of Predation Based on Agency Problems in Financial Contracting," American Economic Review, American Economic Association, vol. 80(1), pages 93-106, March.
  25. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  26. Dimitri Vayanos, 2001. "Strategic Trading in a Dynamic Noisy Market," Journal of Finance, American Finance Association, vol. 56(1), pages 131-171, 02.
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