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Fire Sales Forensics: Measuring Endogenous Risk

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  • Rama Cont

    ()
    (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Paris VI - Pierre et Marie Curie - Université Paris VII - Paris Diderot)

  • Lakshithe Wagalath

    ()
    (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Paris VI - Pierre et Marie Curie - Université Paris VII - Paris Diderot)

Abstract

We propose a tractable framework for quantifying the impact of fire sales on the volatility and correlations of asset returns in a multi-asset setting. Our results enable to quantify the impact of fire sales on the covariance structure of asset returns and provide a quantitative explanation for spikes in volatility and correlations observed during liquidation of large portfolios. These results allow to estimate the impact and magnitude of fire sales from observation of market prices: we give conditions for the identifiability of model parameters from time series of asset prices, propose an estimator for the magnitude of fire sales in each asset class and study the consistency and large sample properties of the estimator. We illustrate our estimation methodology with two empirical examples: the hedge fund losses of August 2007 and the Great Deleveraging following the Lehman default.

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Bibliographic Info

Paper provided by HAL in its series Working Papers with number hal-00697224.

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Date of creation: 12 May 2012
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Handle: RePEc:hal:wpaper:hal-00697224

Note: View the original document on HAL open archive server: http://hal.archives-ouvertes.fr/hal-00697224
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Keywords: fire sales ; endogenous risk ; systemic risk ; liquidity ; financial econometrics ; correlation ; volatility;

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  1. Greenwood, Robin & Thesmar, David, 2011. "Stock price fragility," Journal of Financial Economics, Elsevier, Elsevier, vol. 102(3), pages 471-490.
  2. Joan Jasiak & R. Sufana & C. Gourieroux, 2005. "The Wishart Autoregressive Process of Multivariate Stochastic Volatility," Working Papers, York University, Department of Economics 2005_2, York University, Department of Economics.
  3. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Paul Labys, 2003. "Modeling and Forecasting Realized Volatility," Econometrica, Econometric Society, Econometric Society, vol. 71(2), pages 579-625, March.
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  8. Mark Carlson, 2006. "A brief history of the 1987 stock market crash with a discussion of the Federal Reserve response," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2007-13, Board of Governors of the Federal Reserve System (U.S.).
  9. Jotikasthira, Chotibhak & Lundblad, Christian T. & Ramadorai, Tarun, 2009. "Asset fire sales and purchases and the international transmission of financial shocks," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7595, C.E.P.R. Discussion Papers.
  10. Brian H. Boyer & Tomomi Kumagai & Kathy Yuan, 2006. "How Do Crises Spread? Evidence from Accessible and Inaccessible Stock Indices," Journal of Finance, American Finance Association, American Finance Association, vol. 61(2), pages 957-1003, 04.
  11. Shin, Hyun Song, 2010. "Risk and Liquidity," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780199546367, October.
  12. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, American Finance Association, vol. 47(4), pages 1343-66, September.
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Cited by:
  1. Lakshithe Wagalath, 2013. "Modeling the rebalancing slippage of Leveraged Exchange-Traded Funds," Working Papers 2014-ACF-02, IESEG School of Management.

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