Asset fire sales (and purchases) in equity markets

Abstract

This paper examines asset fire sales, and institutional price pressure more generally, in equity markets, using market prices of mutual fund transactions caused by capital flows from 1980 to 2003.Funds experiencing large outflows (inflows) tend to decrease (increase) existing positions, which creates price pressure in the securities held in common by these funds. Forced transactions represent a significant cost of financial distress for mutual funds. We find that investors who trade against constrained mutual funds earn highly significant returns for providing liquidity when few others are willing or able. In addition, future flow-driven transactions are predictable, creating an incentive to front-run the anticipated forced trades by funds experiencing extreme capital flows.

Fire Sales, Indirect Contagion and Systemic Stress-Testing

“…The well-documented occurrence of fire sales during market downturns Ellul et al (2011);Coval and Stafford (2007); Shleifer and Vishny (2011);Jotikasthira et al (2012) is not a coincidence: portfolio constraints -capital, leverage or liquidity constraints-that financial institutions are subject to forces them to deleverage when these constraints are breached as a result of losses, leading to fire sales of assets Kyle and Xiong (2001); Cont and Wagalath (2013). Similar largescale deleveraging is also foreseeable in future stress scenarios, and foreseen by financial institutions themselves: "If we are unable to raise needed funds in the capital markets (including through offerings of equity and regulatory capital securities), we may need to liquidate unencumbered assets to meet our liabilities.…”

“…This deleveraging may be the result of investor redemptions for funds, as evidenced in Ellul et al (2011);Coval and Stafford (2007); Shleifer and Vishny (2011);Jotikasthira et al (2012); but for regulated financial institutions such as banks, large scale deleveraging is mainly driven by portfolio constraints -capital, leverage or liquidity constraints -which may be breached when large losses occur. We have focused for simplicity on leverage constraints, but the model is easily extendable to multiple constraints on portfolios.…”

Systemic risk: the dynamics of model banking systems

“…This is unrealistic. There is a significant literature on 'fire sales' and their general effect on liquidity; that is, their tendency to depress the value of other institutions' external assets (Pulvino 1998;Cifuentes et al 2005;Kaufman 2005;Coval & Stafford 2007;Mitchell et al 2007). As a first step, it is useful to consider such effects on the disposal of assets of a failed bank, ignoring for the moment the indirect effects elsewhere in the system.…”

Measuring Systemic Risk Contribution of International Mutual Funds

“…The fund data is screened in standard procedures following Coval and Stafford (2007) and Jotikasthira, Lundblad, and Ramadorai (2012). First, we exclude funds with TNAs of less than US$5 million throughout the sample period.…”

“…3 On liquidity and financial market runs, and the role of international investors in crisis, see, for instance, Bernardo and Welch (2004) and Manconi, Massa, and Yasuda (2012). 4 See, for example, Ben-Rephael, Kandel, and Wohl (2012);Jotikasthira, Lundblad, and Ramadorai (2012); Coval and Stafford (2007);Baker, Wurgler, and Yuan (2012); Raddatz and Schmukler (2011);Broner, Gelos, and Reinhart (2006); Goldstein and Pauzner (2004);and Kaminsky, Lyons, and Schmukler (2001).…”