Mitigating Fire Sales with Contracts: Theory and Evidence

Abstract

I argue that one rationale for central clearing counterparties (CCPs) is to mitigate inefficiencies associated with distressed asset sales. First, I build a simple model where asset sales give rise to multiple equilibria, and show that a contract resembling a CCP ensures coordination on the Pareto-dominating equilibrium. Second, I empirically study the first event in economic history during which a CCP successfully eliminated inefficient asset sales: the global wool crisis of 1900.