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Predatory Short Selling

  • Markus K. Brunnermeier
  • Martin Oehmke

Financial institutions may be vulnerable to predatory short selling. When the stock of a financial institution is shorted aggressively, leverage constraints imposed by short-term creditors can force the institution to liquidate long-term investments at fire sale prices. For financial institutions that are sufficiently close to their leverage constraints, predatory short selling equilibria co-exist with no-liquidation equilibria (the vulnerability region) or may even be the unique equilibrium outcome (the doomed region). Increased coordination among short sellers expands the doomed region, where liquidation is the unique equilibrium. Our model provides a potential justification for temporary restrictions on short selling of vulnerable institutions and can be used to assess recent empirical evidence on short-sale bans.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19514.

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Date of creation: Oct 2013
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Handle: RePEc:nbr:nberwo:19514
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