When Everyone Runs for the Exit
by Lasse Pedersen
New York University, CEPR, and NBER
The dangers of shouting “fire” in a crowded theater are
well understood, but the dangers of rushing to the exit in the
financial markets are more complex. Yet, the two events share
several features, and I analyze why people crowd into theaters
and trades, why they run, what determines the risk, whether
to return to the theater or trade when the dust settles, and
how much to pay for assets (or tickets) in light of this risk.
These theoretical considerations shed light on the recent global
liquidity crisis and, in particular, the quant event of 2007.
JEL Codes: G11, G12.
(PDF, 23 pages 367 kb)