DP4639 Predatory Trading

Author(s): Markus K Brunnermeier , Lasse Heje Pedersen

Publication Date: September 2004

Keyword(s): dealer exit stress test , liquidity crisis , predation , valuation , liquidity , risk management , systemic risk

JEL(s): G10 , G12 , G23 , G24

Programme Areas: Financial Economics

Link to this Page: www.cepr.org/pubs/dps/DP4639.asp

This Paper studies predatory trading: trading that induces and/or exploits other investors’ need to reduce their positions. We show that if one trader needs to sell, others also sell and subsequently buy back the asset. This leads to price overshooting and a reduced liquidation value for the distressed trader. Hence, the market is illiquid when liquidity is most needed. Further, a trader profits from triggering another trader’s crisis, and the crisis can spill over across traders and across markets.