Predatory Trading in a Rational Market

Theories of predatory trading assume exogenous market depth and/or exogenous distress of the prey. By endogenizing both, I obtain a new feedback loop between liquidity and predatory trading. On the one hand, limited depth helps predators move prices to push the prey into distress. On the other hand, the mere anticipation of the prey's firesale by the market lowers the current price of the asset and makes price impact trader-specific. The prey's price impact decreases before firesales, while predators' increases, making predation cheaper for them. The model predicts that predatory trading occurs in markets with low risk-bearing capacity, and shows that short-selling bans may be ineffective against predatory trading