Predatory Trading Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Initial Positions Necessary Predation Literature Predatory Trading Markus K Brunnermeier Princeton CEPR NBER Lasse Heje Pedersen NYU CEPR NBER Predatory Trading Brunnermeier Pedersen Motivation Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Initial Positions Necessary Predation Literature Forced liquidation of large position is often associated with low liquidity can be very costly cross correlation structure goes wild is a key concern in risk management This paper predatory trading trading that induces and or exploits other traders need to reduce their positions Wall Street conventional wisdom They ll let you in but they won t let you out Predatory Trading Examples Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Initial Positions Necessary Predation Literature Amaranth Long Term Capital Management LTCM If lenders know that a hedge fund needs to sell something quickly they will sell the same asset driving the price down even faster Goldman Sachs and counterparties to LTCM did exactly that in 1998 Goldman admits it was a seller but says it acted honorably and had no confidential information Predatory Trading Examples Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Initial Positions Necessary Predation Literature Amaranth Long Term Capital Management LTCM UBS Warburg and Enron UBS Warburg s proposal to take over Enron s traders without taking over the trading book was opposed on the ground that it would present a predatory trading risk as Enron traders effectively know the contents of the trading book Predatory Trading Examples Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Initial Positions Necessary Predation Literature Amaranth Long Term Capital Management LTCM UBS Warburg and Enron 1987 Crash Brady Report several triggers ignited mechanical price insensitive selling by a number of institution following portfolio insurance strategies The selling by these investors and the prospect of further selling by them encouraged a number of aggressive trading oriented institutions to sell in anticipation of further declines Predatory Trading Examples Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Initial Positions Necessary Predation Literature Amaranth Long Term Capital Management LTCM UBS Warburg and Enron 1987 Crash Askin Granite vs Merrill Lynch Metallgesellschaft MG Predatory Trading Results Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Initial Positions Necessary Predation Literature Under which circumstances occurs predatory trading Price overshooting Systemic risk Time varying liquidity dries up when it is needed the most Distress value orderly liquidation value paper value Contagion Risk management disclosure Predatory Trading Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Initial Positions Necessary Predation Literature Timeline Predatory Trading Model Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Initial Positions Necessary Predation Literature Time is continuous t 0 T Large strategic traders big players i 1 2 I i trading intensity speed aP t i aggregate speed constraint i a A position at time t Rt x i t x i 0 0 ai d individual position limits x x and x x aggregate holding I X X t x j t j 1 Long term traders many small investors aggregate demand Y p 1 p Price p t S X t Predatory Trading Price Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Initial Positions Necessary Predation Literature Price p t S X t where supply S I x hence p t Price impact of order flow permanent i ai P i P i temporary i a A if i a A P equal order priority no temporary price impact for first a buy a sell orders trader i s temporary price impact cost n o G max 0 ai a a ai Predatory Trading Equilibrium Price at t0 Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation p S P p t0 Initial Positions Necessary Predation Literature Ix t0 Predatory Trading Long Run Price Shift Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation S p P Initial Positions Necessary Predation Literature Ix t0 I 1 x Predatory Trading Brunnermeier Pedersen Financial Crisis Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Initial Positions Necessary Predation Literature A trader in crisis default must liquidate forced to sell at a minimum speed of A I What triggers default Part 1 bad luck i is in crisis at time t0 Part 2 wealth fall below critical level W i t W Predatory Trading Objective Function and Equilibrium Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Strategic trader i s objective is to maximize his expected wealth Z T i i i i max E x T a t p t G a t a t dt ai Ai 0 Initial Positions Necessary Predation Literature Definition An equilibrium is a set of processes a1 aI such that for each i ai solves taking a i a1 ai 1 ai 1 aI as given Predatory Trading Preliminary Analysis Brunnermeier Pedersen Model Predation Exogenous Default Single Predator Multiple Predators Endogenous Default Systemic Risk Risk Management Valuation Agent minimizes trading costs as if his own trades do not affect the price Lemma A trader s problem can be written as Z Initial Positions min ai Ai Necessary Predation Literature s t i E T ai t X