Keywords: Strategic investors, contagion, Cournot competition
Abstract: The growing share of financial assets that are held and managed by large institutional investors whose desired
trades move asset prices is at odds with the traditional competitive assumption that investors are small and take
prices as given. This paper relaxes the traditional price-taking assumption and instead presents a dynamic
multiple asset model of imperfect competition in asset markets among large investors who differ in their risk
aversion. The model is used to study asset price dynamics during an LTCM-like scenario in which market rumors of
distressed asset sales are followed at a later date by the sales themselves. Using the model, it is shown that
large investors front-run distressed sales; asset prices overshoot their long-run fundamentals; and asset pricing
models experience temporary breakdown. During the period of model breakdown assets equilibrium returns are
explained by the market portfolio and by transient liquidity factors.
Full paper (1135 KB PDF)
Home | FEDS | List of 2005 FEDS papers
To comment on this site, please fill out our feedback form.
Last update: September 14, 2005