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Cournot Fire Sales

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Abstract

In standard Walrasian macro-finance models, pecuniary externalities such as fire sales lead to overinvestment in illiquid assets or underprovision of liquidity. We investigate whether imperfect competition (Cournot) improves welfare through internalizing the externality and find that this is far from guaranteed. In a standard model of liquidity shocks, when liquidity is sufficiently scarce, Cournot competition leads to even less liquidity than the Walrasian equilibrium. In a standard model of productivity shocks, the Cournot equilibrium over-corrects for the fire-sale externality and holds less capital than socially efficient. Implications for welfare and regulation therefore depend highly on the nature of the shocks and the competitiveness of the industry considered.

Suggested Citation

  • Thomas M. Eisenbach & Gregory Phelan, 2018. "Cournot Fire Sales," Department of Economics Working Papers 2018-01, Department of Economics, Williams College.
  • Handle: RePEc:wil:wileco:2018-01
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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; overinvesment; 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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