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Inequality and asset fire sales

Shiba Suzuki ()

MPRA Paper from University Library of Munich, Germany

Abstract: It is widely acknowledged that fire sales were a critical factor in inducing and exacerbating the financial crises of 2007--2008. The leverage of financial intermediaries, which is defined as the ratio of total assets to capital, is a key factor in causing fire sales. Why do financial intermediaries expand their balance sheets despite subsequently having to sell their assets at discounted prices? To examine this question, we incorporate financial intermediaries into a three-period incomplete market economy model, in which households face countercyclical and uninsured idiosyncratic income shocks. We demonstrate that countercyclical income inequality and market incompleteness result in leveraged investment and subsequent asset fire sales by financial intermediaries in equilibrium. The first contribution of this paper is that we demonstrate that the mechanism between asset prices and leverages could successfully solve the famed asset-pricing puzzles. The second contribution is that we analyze the impact of financial regulation on the welfare of ex ante homogeneous households.

Keywords: arbitrage opportunities; fire sales; income inequality; incomplete markets; leveraged investments; precautionary demand for assets. (search for similar items in EconPapers)
JEL-codes: D52 D53 E44 G01 G12 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2018-12-20
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:90906

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