Fire Sales Forensics: Measuring Endogenous Risk

Abstract : We propose a tractable framework for quantifying the impact of fire sales on the volatility and correlations of asset returns in a multi-asset setting. Our results enable to quantify the impact of fire sales on the covariance structure of asset returns and provide a quantitative explanation for spikes in volatility and correlations observed during liquidation of large portfolios. These results allow to estimate the impact and magnitude of fire sales from observation of market prices: we give conditions for the identifiability of model parameters from time series of asset prices, propose an estimator for the magnitude of fire sales in each asset class and study the consistency and large sample properties of the estimator. We illustrate our estimation methodology with two empirical examples: the hedge fund losses of August 2007 and the Great Deleveraging following the Lehman default.
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Submitted on : Monday, May 14, 2012 - 10:18:16 PM
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Rama Cont, Lakshithe Wagalath. Fire Sales Forensics: Measuring Endogenous Risk. 2012. ⟨hal-00697224⟩

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