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Fire sales forensics: measuring endogenous risk

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  • Rama Cont

    (Laboratoire de Probabilités et Modèles Aléatoires CNRS)

  • Lakshithe Wagalath

    ()
    (IESEG School of Management)

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 test for the presence of fire sales during a given period of time and 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 default of Lehman Brothers in Fall 2008.

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Bibliographic Info

Paper provided by IESEG School of Management in its series Working Papers with number 2014-ACF-01.

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Length: 37 pages
Date of creation: Aug 2013
Date of revision:
Handle: RePEc:ies:wpaper:f201301

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  1. Danielsson, Jon & Shin, Hyun Song & Zigrand, Jean-Pierre, 2004. "The impact of risk regulation on price dynamics," Journal of Banking & Finance, Elsevier, vol. 28(5), pages 1069-1087, May.
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  7. 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 2007-13, Board of Governors of the Federal Reserve System (U.S.).
  8. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
  9. 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.
  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, vol. 61(2), pages 957-1003, 04.
  11. Greenwood, Robin & Thesmar, David, 2011. "Stock price fragility," Journal of Financial Economics, Elsevier, vol. 102(3), pages 471-490.
  12. Jotikasthira, Chotibhak & Lundblad, Christian T. & Ramadorai, Tarun, 2009. "Asset fire sales and purchases and the international transmission of financial shocks," CEPR Discussion Papers 7595, C.E.P.R. Discussion Papers.
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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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