Predatory Trading - Abstract

Oct 22, 2026

Research examines predatory trading, in which one trader induces and/or exploits other investors’ need to reduce positions. The study shows synchronized selling and subsequent buyback that create price overshooting and lower liquidation value for the distressed trader. It further demonstrates how triggering crises can spill across traders and even across markets. Forced liquidation is costly due to large price impact and low liquidity, motivating a continuous-trading framework where strategic large traders limit intensity, yet predation can still propagate financial distress into wider crises.

LanguageEnglish

CategoryResearch & Report

FormatPDF

Pages40

Reading Time1 h 41 min

AccessFree to download

Abstract

Predatory trading mechanism

Forced liquidation and market impact

Strategic interaction framework

Spillovers and crisis propagation

Predatory Trading MARKUS K. BRUNNERMEIER and LASSE HEJE PEDERSEN∗ ABSTRACT 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. LARGE TRADERS FEAR A FORCED LIQUIDATION, especially if their need to liquidate is known by other traders. For example, hedge funds with (nearing) margin calls may need to liquidate, and this could be known to certain counterparties such as the bank financing the trade. Similarly, traders who use portfolio insurance, stop loss orders, or other risk management strategies can be known to liquidate in response to price drops; a short-seller may need to cover his position if the price increases significantly or if his share is recalled (i.e., a “short squeeze”); certain institutions have an incentive to liquidate bonds that are downgraded or in default; and, intermediaries who take on large derivative positions must hedge them by trading the underlying security. A forced liquidation is often very costly since it is associated with large price impact and low liquidity. We provide a new framework for studying the strategic interaction among large traders who have market impact. Traders trade continuously and limit their trading intensity to minimize temporary price impact costs. Some of the traders may end up in financial difficulty, and the resulting need to liquidate is known by the other strategic traders. Our analysis shows that if a distressed large investor is forced to unwind his position (i.e., when he needs liquidity the most), other strategic traders initially trade in the same direction. That is, to profit from price swings, other traders ∗Brunnermeier is affiliated with Princeton University and CEPR; Pedersen is at New York University and NBER. We are grateful for helpful comments from Dilip Abreu, William Allen, Ed Altman, Yakov Amihud, Patrick Bolton, Menachem Brenner, Robert Engle, Stephen Figlewski, Gary Gorton, Rick Green, Joel Hasbrouck, Burt Malkiel, David Modest, Michael Rashes, Jos Scheinkman, Bill Silber, Ken Singleton, Jeremy Stein, Marti Subrahmanyam, Peter Sørensen, Nikola Tarashev, Jeff Wurgler, an anonymous referee, and seminar participants at NYU, McGill, Duke University, Carnegie Mellon University, Washington University, Ohio State University, University of Copenhagen, London School of Economics, University of Rochester, University of Chicago, UCLA, Bank of England, University of Amsterdam, Tilburg University, Wharton, Harvard University, and New York Federal Reserve Bank as well as conference participants at Stanford’s SITE conference and the annual meeting of the European Finance Association. Brunnermeier acknowledges research support from the National Science Foundation. 1826 The Journal of Finance conduct predatory trading and withdraw liquidity instead of providing it. This predatory activity makes liquidation costly and leads to price overshooting. Moreover, predatory trading can even induce the distressed trader’s need to liquidate; hence, predatory trading can enhance the risk of financial crisis. We show that predation is profitable if the market is illiquid and if the distressed trader’s position is large relative to the buying capacity of other traders. Further, predation is most fierce if there are few predators. These findings are in line with anecdotal evidence as summarized in Table I. A well-known example is the alleged trading against Long Term Capital Management’s (LTCM’s) positions in the fall of 1998 . Business Week wrote: ... if lenders know that a hedge fund needs to sell something quick

FAQs

What is predatory trading in the paper’s framework?

Predatory trading refers to trading that induces and/or exploits other investors’ need to reduce their positions.

How does predatory trading affect prices and liquidation value?

If one trader needs to sell, others may sell as well and then buy back, producing price overshooting and reducing the distressed trader’s liquidation value.

Why can a trader’s crisis spread across markets?

A distressed trader’s forced unwinding, combined with predatory trading, can cause price drops that bring other traders into difficulty, enabling further predation and producing ripple effects across traders and markets.

Oct 22, 2026

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