Working Paper: CEPR ID: DP4639
Authors: Markus K. Brunnermeier; Lasse Heje Pedersen
Abstract: This Paper studies predatory trading: trading that induces and/or exploits other investors? need to reduce their positions. We show that if one trader needs to sell, others also sell and subsequently buy back the asset. This leads to price overshooting and a reduced liquidation value for the distressed trader. Hence, the market is illiquid when liquidity is most needed. Further, a trader profits from triggering another trader?s crisis, and the crisis can spill over across traders and across markets.
Keywords: dealer exit; stress test; liquidity; liquidity crisis; predation; risk management; systemic risk; valuation
JEL Codes: G10; G12; G23; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| A distressed trader (F19) | Selling behavior in other traders (D16) |
| Selling behavior in other traders (D16) | Price overshooting (E31) |
| A distressed trader (F19) | Reduced liquidity (G19) |
| Predatory trading (G18) | Distressed trader's need to liquidate (G33) |
| Distressed trader's position size (C69) | Profitability of predatory trading (D43) |
| Predatory trading (G18) | Risk of financial crisis (G01) |
| Distressed trader (G19) | Further distress among other traders (F69) |
| Number of predators (C92) | Intensity of predatory behavior (C92) |
| Predatory trading (G18) | Reduced liquidity of assets (G19) |