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Hyun Song Shin on the New Financial Stability Risks

Odd Lots

NOTE

Perverse Demand Response: Understanding Price Declines and Increased Sales in Stress Episodes

In stressful market episodes, a price decline can lead to more sales, causing further price declines. This perverse demand response can be caused by leverage or leverage-like behavior. For example, in the mortgage market, when rates go up, the duration increases, leading to more sales. The same can happen in sectors like pension funds or life insurance where assets have shorter durations than liabilities. When rates rise, these sectors end up selling despite the rate increase. The UK story is a combination of leverage and the LDI fund aspect. Even supposedly boring sectors can be the source of these types of market events.

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