Illiquidity And Under-Valuation Of Firms

Date Added: Oct 2009
Format: PDF

The authors study a competitive model in which market incompleteness implies that debt-financed firms may default in some states of nature and default may lead to the sale of the firms' assets at fire sale prices when markets are illiquid. This incompleteness is the only friction in the model and the only cost of default. The anticipation of such losses alone may distort firms' investment decisions. They characterize the conditions under which fire sales occur in equilibrium and their consequences on firms' investment decisions.