An Asymptotic Model of Fire Sales in Financial Systems

In this article, we propose a model for fire sales (price-mediated contagion). We derive analytic formulas for the final state (fraction of defaulted institutions and total price impact) of large financial systems after being... [ view full abstract ]

In this article, we propose a model for fire sales (price-mediated contagion). We derive analytic formulas for the final state (fraction of defaulted institutions and total price impact) of large financial systems after being hit by an initial shock. Further, we complement our model by a channel of default contagion. At this we apply results from (Detering et. al., 2017), (Detering et. al. 2018) derived by asymptotic random graph methods and extend them to the non-continuous setting induced by the fire sales. Finally, we provide criteria that determine whether a certain financial system is resilient or prone to small initial shocks and furthermore give sufficient capital requirements for financial systems to be resilient.