An Equilibrium Search Model of Fire Sales

This paper presents a novel approach to the theory of fire sales, where an asset is sold for a price below its fundamental value. Specifically, we model the “urgency to sell” motivation that pushes some unlucky sellers in the market to become anxious (desperate) about liquidating their asset because failing to do so would cause them to incur a cost. Homogenous buyers strategically choose when to enter the market and what price to offer, knowing that some sellers are more motivated, but do not know the type of the seller they meet. We characterize equilibrium prices in this economy both in the steady state and on the transition path as the economy converges to a new steady state after a permanent demand shock. We find that prices oscillate, rather than monotonically converging to the steady state. Moreover, the dynamic behavior of prices indicate overshooting, where sometimes prices fall below their long run equilibrium value and rise above it, depending on the proportion of desperate to relaxed sellers as well as the number of buyers that would clear the market.