A Market Risk Approach to Liquidity Risk and Financial Contagion
According to traditional literature, liquidity risk in individual banks can turn into a wide-system financial crisis when either interbank credit exposures or bank runs are present. This paper shows that this phenomenon can also arise when individual liquidity risk transforms into wide-system marketrisk (even in the absence of bank runs and interbank credit networks). This happens when banks try to sell some portion of its assets in order to overcome a liquidity shortage (individual liquidity risk). These sales depress the market price of assets if demand is not perfectly elastic. Given the fact thatbanks mark to market the asset book, the fall of market price reduces the value of assets of every bank in the system (wide-system market risk), leaving them less suited for future liquidity shortages and therefore more prone to bankruptcies. The paper rationalizes this idea through the simulation of a model that tries to capture the behavior of a liquidity manager that faces shocks on bank deposits and loans. The main results suggest that the extentof financial contagion depends crucially on the size of the market for assets.
Volume (Year): (2006)
Issue (Month): ()
|Contact details of provider:|| |
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- De Bandt, Olivier & Hartmann, Philipp, 2000.
"Systemic risk: A survey,"
Working Paper Series
0035, European Central Bank.
When requesting a correction, please mention this item's handle: RePEc:col:000107:007512. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Espe)
If references are entirely missing, you can add them using this form.