Paradox of financial fire sales and the role of arbitrage capital

Dow, J and Jungsuk, H (2016) Paradox of financial fire sales and the role of arbitrage capital. The Journal of Finance. ISSN 0022-1082 (Submitted)

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How can fire sales for financial assets happen when the economy contains well capitalized, but non-specialist investors? Our explanation combines rational expectations equilibrium and "lemons" models. When specialist (informed) market participants are liquidity-constrained, prices become less informative. This creates an adverse selection problem, decreasing the supply of high-quality assets, and lowering valuations by non-specialist (uninformed) investors, who become unwilling to supply capital to support the price. In normal times, arbitrage capital can "multiply" itself by making uninformed capital function as informed capital, but in a crisis this stabilizing mechanism fails.

Item Type: Article
Additional Information: © 2017 The American Finance Association
Subjects: S > Speculation
Subject Areas: Finance
Date Deposited: 04 Jul 2017 10:22
Last Modified: 14 Jul 2017 15:41

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