Taking Regulation Seriously: Fire Sales Under Solvency and Liquidity Constraints

Coen, Jamie; Lepore, Caterina; Schaanning, Eric

doi:10.2139/ssrn.3378586

Cited by 15 publications

(33 citation statements)

References 30 publications

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“…Meanwhile, Cont and Schaanning (2017), Greenwood et al (2015) and Duarte and Eisenbach (2015) assume that banks actively target their leverage ratio. Additionally, Coen et al (2019) consider the case where banks are constrained by leverage, risk-weighted capital and liquidity regulations. Recently, the quantification of systemic risk in non-banking sectors has gained interest in the literature.…”

Section: Literature Reviewmentioning

confidence: 99%

Modelling Fire Sale Contagion Across Banks and Non-banks

2020

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We study the impact of common asset holdings across different financial sectors on financial stability. In particular, we model indirect contagion via fire sales across UK banks and non-banks. Fire sales are triggered by different responses to a financial shock: banks and non unit-linked insurers are subject to regulatory constraints, while funds and unit-linked insurers are obliged to meet investor redemptions. We use our model to conduct a systemic stress simulation under different initial shock scenarios and institutions' selling strategies. We find that performing a stress simulation that does not account for common asset holdings across multiple sectors can severely underestimate the fire sale losses in the financial system.

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Section: Literature Reviewmentioning

confidence: 99%

Modelling Fire Sale Contagion Across Banks and Non-banks

2020

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“…The price impact is therefore lower, when the time horizon is longer. The estimation of the parameters will follow the approach used by Cont and Schaaning (2017) and Coen et al (2019), using high-level data on trading volumes and bond indices to estimate the volatility.…”

Section: Price Impact Of Funds Salesmentioning

confidence: 99%

United States

2020

IMF Staff Country Reports

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The U.S. financial system is very large, well-diversified, and home to numerous financial institutions which are significant at a global scale. Eight Global Systemically Important Banks (G-SIBs) are incorporated in the U.S., as well as several other large financial institutions, such as asset managers, insurers, and money market funds. Assets of the financial system amounted to about US$100 trillion at end-2019 and accounted for 500 percent of GDP. While the eight G-SIBs dominate the U.S. banking landscape, banking system assets represent only about 22 percent of total financial system assets. The systemic risk assessment (including stress testing) of this FSAP reflect the highly diversified nature of the U.S. financial system and focuses on banks, mutual and money market funds, insurance companies as well as cross-institutional and cross-sectoral linkages and exposures.

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“…(Caccioli et al, 2014) show that deleveraging cascades arising from common asset holdings lead to a "stable yet fragile" behaviour: contagion has a small likelihood to occur, but may be catastrophic if it does. (Braouezec and Wagalath, 2018) and (Coen et al, 2017) study the optimal deleveraging of bank portfolios in response to stress. (Wagner, 2011) shows that, in the presence of liquidation risks, it is rational for investors to forego some diversification benefits, so as to reduce their exposure to crowding risk.…”

Section: Indirect Contagionmentioning

confidence: 99%

“…Previously, we assumed that deleveraging occurs proportionally across all assets. In the sequel, we assume, similar to the approach taken in (Braouezec and Wagalath, 2018), (Coen et al, 2017) that a bank i needing to liquidate a part of its portfolio will do so by trying to minimise the fire-sales losses that it incurs:…”

Section: Loss-minimising Portfolio Deleveragingmentioning

confidence: 99%

Monitoring indirect contagion

Cont

Schaanning

2019

Journal of Banking & Finance

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We propose two indicators for quantifying the potential exposure of financial institutions to indirect contagion arising from deleveraging of assets in stress scenarios. The first indicator, the Endogenous Risk Index (ERI) captures spillovers across portfolios arising from deleveraging in stress scenarios. The second indicator, the Indirect Contagion Index (ICI) measures the systemic importance of a bank by quantifying the loss its distressed liquidation would inflict on other institutions.Both are computable from portfolio holdings of financial institutions and measures of market depth for the assets held in the portfolio. We discuss the micro-foundation of these indicators and apply them to the analysis of the vulnerability of the European banking system to indirect contagion.Using data on portfolio holdings of European banks, we show that our indicators correlate to the magnitude of fire-sales losses in simulated stress scenarios, thus providing a simple to compute proxy for the outcome of stress tests. We also show that the information provided by our indicators on the systemic importance of banks is different from indicators based on size, thereby providing a measure of interconnectedness complementary to those currently used by supervisors.

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Taking Regulation Seriously: Fire Sales Under Solvency and Liquidity Constraints

Cited by 15 publications

References 30 publications

Modelling Fire Sale Contagion Across Banks and Non-banks

Modelling Fire Sale Contagion Across Banks and Non-banks

United States

Monitoring indirect contagion

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