Predatory Trading, Price Overshooting, and Liquidation Value
Summary
The document clarifies the meaning of price overshooting in the context of predatory trading. A distressed investor’s need to sell can prompt other traders to sell as well, intensifying downward price pressure; they may later buy back the asset. Such activity can push the market price beyond its eventual level and reduce the proceeds available to the investor who must liquidate.
The key distinction is that overshooting describes a price path that passes its eventual destination before moving back, not necessarily a sharp increase or a price that is too high. In this case, the overshoot can be downward, so it is consistent with a reduced liquidation value. The note offers a concise conceptual clarification but does not explain the paper’s model, quantify the effects, or discuss when predatory trading is likely to occur.
Key ideas
- Predatory trading can amplify selling when another investor is forced to liquidate.
- Price overshooting means the price temporarily passes its eventual level before returning toward it.
- Overshooting can occur downward and does not necessarily mean that the price rises.
- A downward overshoot can lower the proceeds received by a distressed seller.
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Full text
# How to clarify "Predatory trading" process? # How to clarify "Predatory trading" process? Brunnermeier, 2005 studied the "predatory trading" > This paper studies predatory trading, trading that induces and/or exploits the need of other investors 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. From reading the definition, I have some unclear points: Regarding this part "We show that if one trader needs to sell, others also sell and subsequently buy back the asset.". My understanding is that if one investor knows that another investor needs to sell, this investor will sell to reduce the price and then buy back the asset with the lower price. And, what is unclear to me is how it leads to "This leads to price overshooting and a reduced liquidation value for the distressed trader". From my understanding, "price overshooting" means that "price drastically increase". But when an investor sells together like that, how come the price increase? Apart from that, "liquidation value" is the price of the asset. So in the same sentence, the author says that the asset price increase(price overshooting) or decrease (reduced liquidation value), which means I may fall into a fallacy of explanation. ## Answer by Bob Jansen (score 1, accepted) https://quant.stackexchange.com/a/68626 Price overshooting doesn’t necessarily imply that the price is too high. It implies that if the price changes from one level to another level, the price first moves past the final level and then back to the final level.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.