Staff Reports
Cournot Fire Sales
Number 837
February 2018

JEL classification: D43, D62, E44, G18, G21

Authors: Thomas Eisenbach and Gregory Phelan

In standard Walrasian macro-finance models, pecuniary externalities such as fire sales lead to overinvestment in illiquid assets or underprovision of liquidity. We investigate whether imperfect competition (Cournot) improves welfare through internalizing the externality and find that this is far from guaranteed. In a standard model of liquidity shocks, when liquidity is sufficiently scarce, Cournot competition leads to even less liquidity than the Walrasian equilibrium. In a standard model of productivity shocks, the Cournot equilibrium overcorrects for the fire-sale externality and holds less capital than socially efficient. Implications for welfare and regulation therefore depend highly on the nature of the shocks and the competitiveness of the industry considered.

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AUTHOR DISCLOSURE STATEMENT(S)
Thomas Eisenbach
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.

Gregory Phelan
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.