Liquidity Risk and Contagion

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.

 

To read this paper, please contact the Society at info@actuaries.ie

Source
Wiley Online Library
Length of Resource
10
Author
Journal of the European Economic Association
Date Published
Publication Type
paper
Resource Type
academic

ResourceID: 72467

< Return to Library