A Theory of Slow-Moving Capital and Contagion
Fire sales that occur during crises beg the question of why sufficient outside capital does not move in quickly to take advantage of fire sales, or in other words, why outside capital is so slow-moving. We propose an answer to this puzzle in the context of an equilibrium model of capital allocation. Keeping capital in liquid form in anticipation of possible fire sales entails costs in terms of foregone profitable investments. Set against this, those same profitable investments are rendered illiquid in future due to agency problems embedded with expertise. We show that a robust consequence of this trade-off between making investments today and waiting for arbitrage opportunities in future is the combination of occasional fire sales and limited stand-by capital that moves in only if fire-sale discounts are sufficiently deep. An extension of our model to several types of investments gives rise to a novel channel for contagion where sufficiently adverse shocks to one type can induce fire sales in other types that are fundamentally unrelated, provided arbitrage activity in these investments is sourced from a common pool of capital.
|Date of creation:||Jan 2009|
|Date of revision:|
|Contact details of provider:|| Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ.|
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820
|Order Information:|| Email: |
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Pavlova, Anna & Rigobon, Roberto, 2008.
"The Role of Portfolio Constraints in the International Propagation of Shocks,"
CEPR Discussion Papers
6647, C.E.P.R. Discussion Papers.
- Anna Pavlova & Roberto Rigobon, 2008. "The Role of Portfolio Constraints in the International Propagation of Shocks," Review of Economic Studies, Oxford University Press, vol. 75(4), pages 1215-1256.
- Albert S. Kyle, 2001. "Contagion as a Wealth Effect," Journal of Finance, American Finance Association, vol. 56(4), pages 1401-1440, 08.
- Holmstrom, B & Tirole, J, 1996.
"Private and Public Supply of Liquidity,"
96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
- Andrei Shleifer ad Robert W. Vishny, 1995.
"The Limits of Arbitrage,"
Harvard Institute of Economic Research Working Papers
1725, Harvard - Institute of Economic Research.
- Darrell Duffie & Bruno Strulovici, 2011.
"Capital Mobility and Asset Pricing,"
NBER Working Papers
17296, National Bureau of Economic Research, Inc.
- Bruno Strulovici & Darrell Duffie, 2009. "Capital Mobility and Asset Pricing," 2009 Meeting Papers 87, Society for Economic Dynamics.
- Darrell Duffie & Bruno Strulovici, 2009. "Capital Mobility and Asset Pricing," Discussion Papers 1478, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Mark Mitchell & Lasse Heje Pedersen & Todd Pulvino, 2007.
"Slow Moving Capital,"
NBER Working Papers
12877, National Bureau of Economic Research, Inc.
- Shleifer, Andrei & Vishny, Robert W., 1992.
"Liquidation Values and Debt Capacity: A Market Equilibrium Approach,"
27692663, Harvard University Department of Economics.
- 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.
- Kaminsky, Graciela & Schmukler, Sergio, 2001.
"Emerging markets instability: do sovereign ratings affect country risk and stock returns?,"
Policy Research Working Paper Series
2678, The World Bank.
- Graciela Kaminsky & Sergio L. Schmukler, 2002. "Emerging Market Instability: Do Sovereign Ratings Affect Country Risk and Stock Returns?," World Bank Economic Review, World Bank Group, vol. 16(2), pages 171-195, August.
- Joshua D. Coval & Erik Stafford, 2005.
"Asset Fire Sales (and Purchases) in Equity Markets,"
NBER Working Papers
11357, National Bureau of Economic Research, Inc.
- Coval, Joshua & Stafford, Erik, 2007. "Asset fire sales (and purchases) in equity markets," Journal of Financial Economics, Elsevier, vol. 86(2), pages 479-512, November.
- Franklin Allen & Douglas Gale, 1998.
"Optimal Financial Crises,"
Journal of Finance,
American Finance Association, vol. 53(4), pages 1245-1284, 08.
- Rigobon, Roberto, 2002.
"The curse of non-investment grade countries,"
Journal of Development Economics,
Elsevier, vol. 69(2), pages 423-449, December.
- Per Strömberg, 2000.
"Conflicts of Interest and Market Illiquidity in Bankruptcy Auctions: Theory and Tests,"
Journal of Finance,
American Finance Association, vol. 55(6), pages 2641-2692, December.
- Per Stromberg, . "Conflicts of Interest and Market Illiquidity in Bankruptcy Auctions: Theory and Tests," CRSP working papers 459, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
- Laura E. Kodres & Matthew Pritsker, 2002. "A Rational Expectations Model of Financial Contagion," Journal of Finance, American Finance Association, vol. 57(2), pages 769-799, 04.
- Berger, Philip G. & Ofek, Eli & Swary, Itzhak, 1996. "Investor valuation of the abandonment option," Journal of Financial Economics, Elsevier, vol. 42(2), pages 257-287, October.
- Oliver Hart & John Moore, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 841-879.
When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:7147. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.