FIN-03-042

Predatory Trading

December 2003

Markus K. Brunnermeier and Lasse Heje Pedersen

ABSTRACT
This paper studies predatory trading: trading that induces and/or exploits other investors’s 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.

Markus K. Brunnermeier
Institution: Department of Economics, Bendheim Center for Finance, Princeton University
Phone: (609) 258-4050
Fax: (609) 258-0771
Email: markus@princeton.edu
Home Page: http://www.princeton.edu/~markus

Lasse Heje Pedersen
Institution: Stern School of Business, New York University
Phone: (212) 998-0359
Fax: (212) 995-4233
Email: lpederse@stern.nyu.edu
Home Page: http://www.stern.nyu.edu/~lpederse

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