A Market Based Solution for Fire Sales and Other Pecuniary Externalities

Abstract

We show how bundling, exclusivity and additional markets internalize fire sale and other pecuniary externalities. Ex ante competition can achieve a constrained efficient allocation. The solution can be put rather simply: create segregated market exchanges which specify prices in advance and price the right to trade in these markets so that participant types pay, or are compensated, consistent with the market exchange they choose and that type's excess demand contribution to the price in that exchange. We do not need to identify and quantify some policy intervention. With the appropriate ex ante design we can let markets solve the problem.

Securitization and aggregate investment efficiency

“…See for exampleDeMarzo (2005),Coval, Jurek, and Stafford (2009),Gorton and Metrick (2012), andKiff and Kisser (2014).5 For example, differences in the accounting treatment of derivatives (GAAP versus IFRS) imply very different levels of leverage for large banks.6 Specifically Article 122a of the European Capital Requirements Directive and Section 941 of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act both require a five percent minimum retention rate by securitizers or originators, with exceptions for various types of underlying assets. Notably, "qualified" residential mortgage backed securities, which are backed by loans that meet a specific underwriting criteria.7 In a general framework with pecuniary externalities,Kilenthong and Townsend (2016) consider how to implement constrained-efficient outcomes via alternative market-based mechanisms.…”