“Investment Externalities in Models of Fire Sales”
Abstract: In canonical models with financial constraints, the possibility of fire sales creates a pecuniary externality that results in ex-ante overinvestment. I show that this result is sensitive to the microfoundations for fire sales. If they result from asymmetric information instead of misallocation, the overinvestment result is reversed. However, there may be a tradeoff between present and future underinvestment. Macroprudential policy may need to treat different types of investment differently.
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