Liquidity Risk and Contagion
نویسندگان
چکیده
This paper explores liquidity risk in a system of interconnected financial institutions when these institutions are subject to regulatory solvency constraints and mark their assets to market. When the market’s demand for illiquid assets is less than perfectly elastic, sales by distressed institutions depress the market prices of such assets. Marking to market of the asset book can induce a further round of endogenously generated sales of assets, depressing prices further and inducing further sales. Contagious failures can result from small shocks. We investigate the theoretical basis for contagious failures and quantify them through simulation exercises. Liquidity requirements on institutions can be as effective as capital requirements in forestalling contagious failures. (JEL: G21, G28)
منابع مشابه
Credit Risk Transfer and Contagion∗
Some have argued that recent increases in credit risk transfer are desirable because they improve the diversification of risk. Others have suggested that they may be undesirable if they increase the risk of financial crises. Using a model with banking and insurance sectors, we show that credit risk transfer can be beneficial when banks face uniform demand for liquidity. However, when they face ...
متن کاملEpidemics of Liquidity Shortages in Interbank Markets
Financial contagion from liquidity shocks has being recently ascribed as a prominent driver of systemic risk in interbank lending markets. Building on standard compartment models used in epidemics, here we develop an EDB (Exposed-Distressed-Bankrupted) model for the dynamics of liquidity shocks reverberation between banks, and validate it on electronic market for interbank deposits data. We sho...
متن کاملContagion Channels between Real Estate and Financial Markets∗
The recent crisis has demonstrated the close linkages between various asset classes within a country as well as the association between assets internationally. The aim of this research is to provide for a better understanding of some of these linkages by conducting an empirical investigation of the channels underlying the risk of contagion between real estate and financial markets in the United...
متن کاملBank networks, interbank liquidity runs and the identification of banks that are Too InterConnected to Fail
We simulate interbank market contagion, enriching the standard transmission channel based on credit losses and capital, with new channels like funding liquidity losses, fire assets sales and active liquidity runs on infected banks, employing a testing dataset of Russian bilateral interbank exposures. Allowing active liquidity runs on infected banks is crucial to capture reality with the simulat...
متن کاملA liquidity risk stress-testing framework with interaction between market and credit risks
A liquidity risk stress-testing framework with interaction between market and credit risks Eric Wong* and Cho-Hoi Hui* This version: April 11, 2011 Abstract This study develops a framework for stress testing banks’ liquidity risk, where liquidity and default risks can stem from market risk arising from asset price shocks. The risks are assumed to be transmitted through three channels. First, ba...
متن کاملAn Optimization View of Financial Systemic Risk Modeling: Network Effect and Market Liquidity Effect
Financial institutions are interconnected directly by holding debt claims against each other (the network channel), and they are also bound by the market when selling assets to raise cash in distressful circumstances (the liquidity channel). The goal of our study is to investigate how these two channels of risk interact to propagate individual defaults to a system-wide catastrophe. We formulate...
متن کامل