Working Paper: CEPR ID: DP7436
Authors: Lasse Heje Pedersen
Abstract: The dangers of shouting ``fire'' in a crowded theater are well understood, but the dangers of rushing to the exit in the financial markets are more complex. Yet, the two events share several features, and I analyze why people crowd into theaters and trades, why they run, what determines the risk, whether to return to the theater or trade when the dust settles, and how much to pay for assets (or tickets) in light of this risk. These theoretical considerations shed light on the recent global liquidity crisis and, in particular, the quant event of 2007.
Keywords: asset pricing; crisis; liquidity; risk; quant; risk management; run; unconventional monetary policy
JEL Codes: E2; E44; E52; G1; G11; G12; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| crowding into trades or theaters (Z11) | panic response (H12) |
| crowd density (C69) | decision to sell or liquidate (G33) |
| risk management quality (L15) | decision to sell or liquidate (G33) |
| panic runs (H12) | significant price drops (P22) |
| significant price drops (P22) | further forced sales (Y50) |
| further forced sales (Y50) | systemic risk (E44) |
| initial selling pressure (G14) | price declines (E30) |
| price declines (E30) | further forced sales (Y50) |