Forced Portfolio Liquidation

Christian Ewerhart and Natacha Valla

Working papers from Banque de France

Abstract: We study the problem of a leveraged investor that is forced to unwind a significant fraction of its portfolio in a collection of illiquid markets. It is shown that markets may become disrupted in response to a relatively small liquidity shock. As a consequence, the probability of default can be much higher than suggested by standard risk measures. We also study the impact of successful liquidation on relative asset prices. Our analysis suggests that effective risk management of leveraged financial entities should focus on the entity's potential to generate emergency cash-flows net of third-party claims for liquidity.

Keywords: Portfolio liquidation; Market disruption; Leverage; Determinants of asset liquidity; Hedge funds; Structured credit. (search for similar items in EconPapers)
JEL-codes: E58 G11 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2007
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:179

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