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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/27875
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| Title: | A Theory of Slow-Moving Capital and Contagion |
| Authors: | Acharya, Viral
Shin, Hyun Song
Yorulmazer, Tanju |
| Issue Date: | 6-Feb-2009 |
| Series/Report no.: | FIN-08-029 |
| Abstract: | Fire sales that occur during crises beg the question of why sufficient
outside capital does not move in quickly to take advantage of fire
sales, or in other words, why outside capital is so
"slow-moving". We propose an answer to this puzzle in the
context of an equilibrium model of capital allocation. Keeping capital
in liquid form in anticipation of possible fire sales entails costs in
terms of foregone profitable investments. Set against this, those same
profitable investments are rendered illiquid in future due to agency
problems embedded with expertise. We show that a robust consequence of
this trade-off between making investments today and waiting for
arbitrage opportunities in future is the combination of occasional fire
sales and limited stand-by capital that moves in only if fire-sale
discounts are sufficiently deep. An extension of our model to several
types of investments gives rise to a novel channel for contagion where
sufficiently adverse shocks to one type can induce fire sales in other
types that are fundamentally unrelated, provided arbitrage activity in
these investments is sourced from a common pool of capital. |
| URI: | http://hdl.handle.net/2451/27875 |
| Appears in Collections: | Finance Working Papers
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