Liquidity and Liquidation

David Kelly and Stephen LeRoy

University of California at Santa Barbara, Economics Working Paper Series from Department of Economics, UC Santa Barbara

Abstract: The manager of a firm that is selling an illiquid asset has discretion as to the sale price: if he chooses a high (low) selling price, early sale is unlikely (likely). If the manager has the option to default on the debt that is collaterized by the illiquid asset, the optimal selling price depends on whether the manager acts in the interest of the owners or the creditors. We model the former case. In the preferred equilibrium, the owner will always offer the illiquid asset for sale at a strictly higher price than he paid, and he will always default if he fails to sell. As a result, the illiquid asset changes hands at successively higher prices; the price inflation terminates upon the first failure to sell, which results in a default chain.

Keywords: Liquidity; Liquidation (search for similar items in EconPapers)
Date: 2001-12-07
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Journal Article: Liquidity and Liquidation (2007)
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