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Cournot Fire Sales

Author

Listed:
  • Thomas M. Eisenbach
  • Gregory Phelan

Abstract

In standard Walrasian macro-finance models, pecuniary externalities due to fire sales lead to excessive borrowing and insufficient liquidity holdings. We investigate whether imperfect competition (Cournot) improves welfare through internalizing the externality and find that this is far from guaranteed. Cournot competition can overcorrect the inefficiently high borrowing in a standard model of levered real investment. In contrast, Cournot competition can exacerbate the inefficiently low liquidity in a standard model of financial portfolio choice. Implications for welfare and regulation are therefore sector-specific, depending both on the nature of the shocks and the competitiveness of the industry.

Suggested Citation

  • Thomas M. Eisenbach & Gregory Phelan, 2018. "Cournot Fire Sales," Staff Reports 837, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednsr:837
    Note: Revised November 2020. Previous title: “Cournot Fire Sales in Real and Financial Markets”
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    References listed on IDEAS

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    Cited by:

    1. Ryuichiro Izumi & Yang Li, 2021. "Financial Stability with Fire Sale Externalities," Wesleyan Economics Working Papers 2021-002, Wesleyan University, Department of Economics.

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    More about this item

    Keywords

    liquidity; fire sales; overinvestment; financial regulation; macroprudential regulation;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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