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Inequality and asset fire sales

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  • Suzuki, Shiba

Abstract

It is widely acknowledged that fire sales were a critical factor in inducing and exacerbating the financial crises of 2007--2008. The leverage of financial intermediaries, which is defined as the ratio of total assets to capital, is a key factor in causing fire sales. Why do financial intermediaries expand their balance sheets despite subsequently having to sell their assets at discounted prices? To examine this question, we incorporate financial intermediaries into a three-period incomplete market economy model, in which households face countercyclical and uninsured idiosyncratic income shocks. We demonstrate that countercyclical income inequality and market incompleteness result in leveraged investment and subsequent asset fire sales by financial intermediaries in equilibrium. The first contribution of this paper is that we demonstrate that the mechanism between asset prices and leverages could successfully solve the famed asset-pricing puzzles. The second contribution is that we analyze the impact of financial regulation on the welfare of ex ante homogeneous households.

Suggested Citation

  • Suzuki, Shiba, 2018. "Inequality and asset fire sales," MPRA Paper 90906, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:90906
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    More about this item

    Keywords

    arbitrage opportunities; fire sales; income inequality; incomplete markets; leveraged investments; precautionary demand for assets.;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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