Report

Cournot Fire Sales

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 externality 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 therefore sector-specific, depending both on the nature of the shocks and the competitiveness of the industry.

Keywords: liquidity; fire sales; overinvestment; financial regulations; macroprudential regulations;

JEL Classification: D43; D62; E44; G18; G21;

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2018-02-01

Number: 837

Note: Revised November 2020. Previous title: “Cournot Fire Sales in Real and Financial Markets”