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Cournot Fire Sales

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Abstract

In standard Walrasian macro-finance models, pecuniary externalities due to fire sales lead to excessive borrowing and insufficient liquidity holdings. We investigate whether imperfect competition (Cournot) improves welfare through internalizing the external- ity and find that this is far from guaranteed. Cournot competition can overcorrect the inefficiently high borrowing in a standard model of levered real investment. In contrast, Cournot competition can exacerbate the inefficiently low liquidity in a standard model of financial portfolio choice. Implications for welfare and regulation are there- fore sector-specific, depending both on the nature of the shocks and the competitive- ness of the industry.

Suggested Citation

  • Thomas M. Eisenbach & Gregory Phelan, 2020. "Cournot Fire Sales," Department of Economics Working Papers 2020-10, Department of Economics, Williams College.
    • Handle: RePEc:wil:wileco:2020-10
    Note: This is a revised version of paper 2018-01.
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    Keywords

    liquidity; fire sales; overinvesment; financial regulation; macroprudential regulation;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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