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Financial Intermediation and Fire Sales with Liquidity Risk Pricing

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  • Yuteng Cheng
  • Roberto Robatto

Abstract

We provide a theory of fire sales in which potential buyers are subject to liquidity shocks and frictions that limit their ability to resell assets. The model predictions align with some stylized facts about the large sales of corporate bonds and Treasury securities during the COVID-19 economic crisis. The equilibrium is constrained efficient under weak conditions that apply if one interprets the key agents in the model as money market funds or mutual funds. Thus, as viewed through the lens of the model, the liquidity requirements proposed by the U. S. Securities and Exchange Commission for these intermediaries could hurt the economy.

Suggested Citation

  • Yuteng Cheng & Roberto Robatto, 2024. "Financial Intermediation and Fire Sales with Liquidity Risk Pricing," Staff Working Papers 24-18, Bank of Canada.
    • Handle: RePEc:bca:bocawp:24-18
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    References listed on IDEAS

    as
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    4. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
    5. Coval, Joshua & Stafford, Erik, 2007. "Asset fire sales (and purchases) in equity markets," Journal of Financial Economics, Elsevier, vol. 86(2), pages 479-512, November.
    6. O'Hara, Maureen & Zhou, Xing (Alex), 2021. "Anatomy of a liquidity crisis: Corporate bonds in the COVID-19 crisis," Journal of Financial Economics, Elsevier, vol. 142(1), pages 46-68.
    7. Yiming Ma & Kairong Xiao & Yao Zeng, 2022. "Mutual Fund Liquidity Transformation and Reverse Flight to Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 35(10), pages 4674-4711.
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    9. Briana Chang, 2018. "Adverse Selection and Liquidity Distortion," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 85(1), pages 275-306.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Asset pricing; Financial markets; Financial system regulation and policies;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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