Clearing prices under margin calls and the short squeeze

TL;DR

This paper develops a model for asset prices under margin calls and short squeezes, identifying a threshold short interest ratio that causes price discontinuities due to feedback effects.

Contribution

It introduces an explicit pricing model incorporating margin calls and short interest thresholds, highlighting conditions for price discontinuities in financial markets.

Findings

Identifies a critical short interest ratio causing price jumps.

Provides an explicit formulation for prices after margin calls.

Highlights feedback loops leading to market discontinuities.

Abstract

In this paper, we propose a clearing model for prices in a financial markets due to margin calls on short sold assets. In doing so, we construct an explicit formulation for the prices that would result immediately following asset purchases and a margin call. The key result of this work is the determination of a threshold short interest ratio which, if exceeded, results in the discontinuity of the clearing prices due to a feedback loop.