Liquidity Risk and Contagion

Cifuentes, Rodrigo; Ferrucci, Gianluigi; Shin, Hyun Song

doi:10.1162/1542476054472946

Cited by 274 publications

(454 citation statements)

References 6 publications

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“…Namely, by choosing α = β = 1, s = 0, or C as the zero n × n matrix, we can simply exclude the corresponding extensions from our system. This shows that the models of, e.g., Eisenberg and Noe (2001), Rogers and Veraart (2013), Cifuentes et al (2005), and Elsinger (2009) are special cases of our integrated financial system.…”

Section: Definition 23 a Price-payment Equilibrium Is A Pairmentioning

confidence: 76%

“…As suggested by Cifuentes et al (2005), we consider banks that hold two assets which are external to the banking system: an amount of r ∈ R n + shares of a liquid asset (e.g., cash) and s ∈ R n + shares of an illiquid asset. Assuming that the liquid asset's price remains constant at one monetary unit, the value of bank i's external assets is given by r i + s i q, if the price of the illiquid asset is q.…”

Section: External Assetsmentioning

confidence: 99%

“…While we investigate their joint impact, up to now the literature has only been studying these factors separately: Bankruptcy costs are, for example, considered by Elsinger (2009), Elliott et al (2014), Rogers and Veraart (2013), and Glasserman and Young (2015); cross-holdings, e.g., by Elsinger (2009), Elliott et al (2014), Fischer (2014), Suzuki (2002), and Karl and Fischer (2014). Cifuentes et al (2005) incorporate fire sales into the setting of Eisenberg and Noe (2001); their approach is further extended by Amini et al (2013), Chen et al (2016), Gai and Kapadia (2010), Nier et al (2007), and Feinstein (2017). Most of these papers consider only one extension of the basic framework.…”

Section: Introductionmentioning

confidence: 99%

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The joint impact of bankruptcy costs, fire sales and cross-holdings on systemic risk in financial networks

Weber

Weske

2017

Probab Uncertain Quant Risk

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which permits unrestricted use, distribution, and reproduction in any medium, provided you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license, and indicate if changes were made.Abstract The paper presents a comprehensive model of a banking system that integrates network effects, bankruptcy costs, fire sales, and cross-holdings. For the integrated financial market we prove the existence of a price-payment equilibrium and design an algorithm for the computation of the greatest and the least equilibrium. The number of defaults corresponding to the greatest price-payment equilibrium is analyzed in several comparative case studies. These illustrate the individual and joint impact of interbank liabilities, bankruptcy costs, fire sales and cross-holdings on systemic risk. We study policy implications and regulatory instruments, including central bank guarantees and quantitative easing, the significance of last wills of financial institutions, and capital requirements.

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Section: Definition 23 a Price-payment Equilibrium Is A Pairmentioning

confidence: 76%

Section: External Assetsmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

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The joint impact of bankruptcy costs, fire sales and cross-holdings on systemic risk in financial networks

Weber

Weske

2017

Probab Uncertain Quant Risk

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“…On another strand we find papers like Cifuentes, Ferrucci and Shin [CFS05] and Nier et al [NYYA07], which consider models of systemic risk yet are not based on an initial shock through bank runs as in the previous papers. In [CFS05], there are a number of banks with direct interbank linkages and the authors are interested in examining the effect of changes in asset prices as a single bank failure tracks the sale of assets and a fall in the asset prices, coupled with the mark-to-market regulation and minimum capital ratio requirements.…”

Section: Why Was the Network Initially Formed ?mentioning

confidence: 76%

An Agent-Based Computational Model for Bank Formation and Interbank Networks

Ismail¹

2013

Handbook on Systemic Risk

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The aim of this thesis is to study the role of banking in society and the effect of the interbank market on the performance of the banking system. It starts by reviewing several studies conducted on empirical banking networks and highlighting their salient features in the context of modern network theory. A simulated network resembling the characteristics documented in the empirical studies is then built and its resilience is analyzed with a particular emphasis in documenting the crucial role played by highly interconnected banks.It is our belief that the study of systemic risk and contagion in a banking system is an integral part to the study of the economic role of banks themselves. Thus the current work focuses on the fundamentals of banking and aims at identifying the necessary drivers for a dynamical setup of the interbank market.Through an agent-based model, we address the issues of bank formation, bank runs and the emergence of an interbank market. Starting with heterogeneous individuals, bank formation is viewed as an emergent phenomenon arising to meet the needs for investment opportunities in face of uncertain liquidity preferences. When banks work in isolation (no interbank market), in the long run and through a long experience with bank failures, banking turns into a monopoly or a market with few players.By equipping banks with their own learning tools and allowing an interbank market to develop, fewer bank failures and a less concentrated banking system are witnessed.In addition, through a scenario analysis, it is demonstrated that allowing banks to interact does not weaken the banking system in almost all the cases, and improves the performance on multiple occasions.The work is concluded by studying the effects of a banking system on individuals and the economy in what is called social measures. We establish that the effects of banking on social measures such as consumption level, consumption inequality between individuals, long term investment and economic waste, varies significantly based on the structure of the society.iii

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“…On average, these papers also find low degrees of potential contagion. In reaction to these findings, however, Cifuentes, Ferruci, and Shin (2004) argue that in reality systemic risk may be significantly greater than that identified by the interbank contagion simulations, because market risk may materialize in addition to the credit risk. That is, if following a default by an interbank borrower, bank creditors must liquidate collateral in order to meet their own interbank obligations, then asset prices may fall, thereby lowering banks' values even further and possibly generating new defaults.…”

Section: Literature Reviewmentioning

confidence: 95%

Liquidity Risk in Securities Settlement

Devriese

Mitchell

2005

SSRN Journal

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This paper studies the potential impact on securities settlement systems (SSSs) of a major market disruption, caused by the default of the largest player. A multi-period, multi-security model with intraday credit is used to simulate direct and second-round settlement failures triggered by the default, as well as the dynamics of settlement failures, arising from a lag in settlement relative to the date of trades. The effects of the defaulter's net trade position, the numbers of securities and participants in the market, and participants' trading behavior are also analyzed.We show that in SSSs − contrary to payment systems − large and persistent settlement failures are possible even when ample liquidity is provided. Central bank liquidity support to SSSs thus cannot eliminate settlement failures due to major market disruptions. This is due to the fact that securities transactions involve a cash leg and a securities leg, and liquidity can affect only the cash side of a transaction. Whereas a broad program of securities borrowing and lending might help, it is precisely during periods of market disruption that participants will be least willing to lend securities. Settlement failures can continue to occur beyond the period corresponding to the lag in settlement. This is due to the fact that, upon observation of a default, market participants must form expectations about the impact of the default, and these expectations affect current trading behavior. If, ex post, fewer of the previous trades settle than expected, new settlement failures will occur. This result has interesting implications for financial stability. On the one hand, conservative reactions by market participants to a default − for example by limiting the volume of trades − can result in a more rapid return of the settlement system to a normal level of efficiency. On the other hand, limitation of trading by market participants can reduce market liquidity, which may have a negative impact on financial stability.

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Liquidity Risk and Contagion

Cited by 274 publications

References 6 publications

The joint impact of bankruptcy costs, fire sales and cross-holdings on systemic risk in financial networks

The joint impact of bankruptcy costs, fire sales and cross-holdings on systemic risk in financial networks

An Agent-Based Computational Model for Bank Formation and Interbank Networks

Liquidity Risk in Securities Settlement

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