Caterina Lepore and Jamie Coen

Many commentators on the global financial crisis identified ‘fire sales’ as one of the key mechanisms by which shocks to banks were amplified and transmitted across the wider financial system. When firms in distress sell assets held by other institutions at discounted prices, losses can spread through the financial system as prices fall, amplifying the initial stress. In a working paper published last year, we explored this mechanism by presenting a new model of fire sales. In doing so, we answer the following questions: Which types of financial shocks combine to produce fire sales? How can banks optimally liquidate their portfolios when forced to do so? How big a risk are bank fire sales?

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