In this working paper Townsend and Kilenthong (2016) 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.
This research was funded under the Private Enterprise Development in Low-Income Countries (PEDL) Programme
Kilenthong W. K. and Townsend R. M. (2016) A Market Based Solution for Fire Sales and Other Pecuniary Externalities, 50p.
Published 1 December 2016