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Ehsan Ebrahimy

17 September 2019
It is challenging to explain the collapse in the price of subprime mortgage-backed securities (MBS) during the Financial Crisis of 2008, using the existing models of fire sale. I present a model to demonstrate that fire sales may happen even when there is a relatively sizable pool of natural buyers and in the absence of asymmetric information, due to a coordination failure among buyers: buyers’ waiting to trade at a lower price tomorrow, can lead to a collapse in the price and trade volume today. In particular, I show that when trade is decentralized and participation is endogenous, a medium level of asset demand and liquidity needs that are expected to increase over time create complementarity among buyers’ decisions to wait. This complementarity makes competitive markets prone to coordination failures and fire sales accompanied by a collapse in the trade volume. Fire sales may also be inefficient. I also discuss various policy options to eliminate the risk of fire sales in such a setup.
JEL Code
G01 : Financial Economics→General→Financial Crises
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
D61 : Microeconomics→Welfare Economics→Allocative Efficiency, Cost?Benefit Analysis
D62 : Microeconomics→Welfare Economics→Externalities
D83 : Microeconomics→Information, Knowledge, and Uncertainty→Search, Learning, Information and Knowledge, Communication, Belief
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy