When Everyone Runs for the Exit

by Lasse Pedersen
New York University, CEPR, and NBER

Abstract

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.

 
Full article (PDF, 23 pages 367 kb)