Working Paper: NBER ID: w19514
Authors: Markus K. Brunnermeier; Martin Oehmke
Abstract: Financial institutions may be vulnerable to predatory short selling. When the stock of a financial institution is shorted aggressively, leverage constraints imposed by short-term creditors can force the institution to liquidate long-term investments at fire sale prices. For financial institutions that are sufficiently close to their leverage constraints, predatory short selling equilibria co-exist with no-liquidation equilibria (the vulnerability region) or may even be the unique equilibrium outcome (the doomed region). Increased coordination among short sellers expands the doomed region, where liquidation is the unique equilibrium. Our model provides a potential justification for temporary restrictions on short selling of vulnerable institutions and can be used to assess recent empirical evidence on short-sale bans.
Keywords: No keywords provided
JEL Codes: G01; G20; G21; G23; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Predatory short selling (G34) | forced liquidation of long-term assets (G33) |
| forced liquidation of long-term assets (G33) | diminished equity value (G32) |
| Weak balance sheets (G32) | increased vulnerability to predatory short selling (G34) |
| Coordination among short sellers (G34) | increased likelihood of liquidation (G33) |
| Temporary restrictions on short selling (G18) | welfare-enhancing for vulnerable financial institutions (G28) |
| Short sale bans (G21) | prevent triggering of self-fulfilling downward spirals in stock prices (E32) |