IDEAS home Printed from https://ideas.repec.org/a/eee/ejores/v281y2020i2p449-463.html
   My bibliography  Save this article

Capital regulation under price impacts and dynamic financial contagion

Author

Listed:
  • Feinstein, Zachary

Abstract

We construct a continuous time model for price-mediated contagion precipitated by a common exogenous stress to the banking book of all firms in the financial system. In this setting, firms are constrained so as to satisfy a risk-weight based capital ratio requirement. We use this model to find analytical bounds on the risk-weights for assets as a function of the market liquidity. Under these appropriate risk-weights, we find existence and uniqueness for the joint system of firm behavior and the asset prices. We further consider an analytical bound on the firm liquidations, which allows us to construct exact formulas for stress testing the financial system with deterministic or random stresses. Numerical case studies are provided to demonstrate various implications of this model and analytical bounds.

Suggested Citation

  • Feinstein, Zachary, 2020. "Capital regulation under price impacts and dynamic financial contagion," European Journal of Operational Research, Elsevier, vol. 281(2), pages 449-463.
    • Handle: RePEc:eee:ejores:v:281:y:2020:i:2:p:449-463
    DOI: 10.1016/j.ejor.2019.08.044
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0377221719307143
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.ejor.2019.08.044?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Rama Cont & Lakshithe Wagalath, 2016. "Fire Sales Forensics: Measuring Endogenous Risk," Mathematical Finance, Wiley Blackwell, vol. 26(4), pages 835-866, October.
    2. Gai, Prasanna & Kapadia, Sujit, 2010. "Contagion in financial networks," Bank of England working papers 383, Bank of England.
    3. Yann Braouezec & Lakshithe Wagalath, 2018. "Risk-Based Capital Requirements and Optimal Liquidation in a Stress Scenario," Post-Print hal-02505173, HAL.
    4. Rama Cont & Lakshithe Wagalath, 2012. "Fire Sales Forensics: Measuring Endogenous Risk," Working Papers hal-00697224, HAL.
    5. Nan Chen & Xin Liu & David D. Yao, 2016. "An Optimization View of Financial Systemic Risk Modeling: Network Effect and Market Liquidity Effect," Operations Research, INFORMS, vol. 64(5), pages 1089-1108, October.
    6. Rodrigo Cifuentes & Hyun Song Shin & Gianluigi Ferrucci, 2005. "Liquidity Risk and Contagion," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 556-566, 04/05.
    7. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
    8. Samuel G. Hanson & Anil K. Kashyap & Jeremy C. Stein, 2011. "A Macroprudential Approach to Financial Regulation," Journal of Economic Perspectives, American Economic Association, vol. 25(1), pages 3-28, Winter.
    9. Caccioli, Fabio & Shrestha, Munik & Moore, Cristopher & Farmer, J. Doyne, 2014. "Stability analysis of financial contagion due to overlapping portfolios," Journal of Banking & Finance, Elsevier, vol. 46(C), pages 233-245.
    10. Rama Cont & Eric Schaanning, 2017. "Fire sales, indirect contagion and systemic stress testing," Working Paper 2017/2, Norges Bank.
    11. Yann Braouezec & Lakshithe Wagalath, 2019. "Strategic fire-sales and price-mediated contagion in the banking system," Post-Print hal-02107567, HAL.
    12. Braouezec, Yann & Wagalath, Lakshithe, 2019. "Strategic fire-sales and price-mediated contagion in the banking system," European Journal of Operational Research, Elsevier, vol. 274(3), pages 1180-1197.
    13. Zachary Feinstein, 2017. "Obligations with Physical Delivery in a Multi-Layered Financial Network," Papers 1702.07936, arXiv.org, revised May 2019.
    14. Agostino Capponi & Martin Larsson, 2015. "Price Contagion through Balance Sheet Linkages," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 5(2), pages 227-253.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Zachary Feinstein, 2020. "Reanimating a Dead Economy: Financial and Economic Analysis of a Zombie Outbreak," Papers 2003.09943, arXiv.org.
    2. Bichuch, Maxim & Feinstein, Zachary, 2022. "A repo model of fire sales with VWAP and LOB pricing mechanisms," European Journal of Operational Research, Elsevier, vol. 296(1), pages 353-367.
    3. Giuseppe C. Calafiore & Giulia Fracastoro & Anton V. Proskurnikov, 2022. "Clearing Payments in Dynamic Financial Networks," Papers 2201.12898, arXiv.org, revised May 2022.
    4. Pang, Raymond Ka-Kay & Veraart, Luitgard A. M., 2023. "Assessing and mitigating fire sales risk under partial information," LSE Research Online Documents on Economics 120171, London School of Economics and Political Science, LSE Library.
    5. Feinstein, Zachary & Hałaj, Grzegorz, 2023. "Interbank asset-liability networks with fire sale management," Journal of Economic Dynamics and Control, Elsevier, vol. 155(C).
    6. Liu, Guo & Jin, Zhuo & Li, Shuanming, 2021. "Household Lifetime Strategies under a Self-Contagious Market," European Journal of Operational Research, Elsevier, vol. 288(3), pages 935-952.
    7. Rudiger Frey & Theresa Traxler, 2024. "Playing with Fire? A Mean Field Game Analysis of Fire Sales and Systemic Risk under Regulatory Capital Constraints," Papers 2406.17528, arXiv.org.
    8. Maxim Bichuch & Zachary Feinstein, 2020. "Endogenous inverse demand functions," Papers 2012.08002, arXiv.org, revised Apr 2022.
    9. Maxim Bichuch & Zachary Feinstein, 2020. "A Repo Model of Fire Sales with VWAP and LOB Pricing Mechanisms," Papers 2005.05364, arXiv.org, revised Mar 2021.
    10. Hong Chen & Tan Wang & David D. Yao, 2021. "Financial Network and Systemic Risk—A Dynamic Model," Production and Operations Management, Production and Operations Management Society, vol. 30(8), pages 2441-2466, August.
    11. Banerjee, Tathagata & Feinstein, Zachary, 2021. "Price mediated contagion through capital ratio requirements with VWAP liquidation prices," European Journal of Operational Research, Elsevier, vol. 295(3), pages 1147-1160.
    12. Lukas Gonon & Thilo Meyer-Brandis & Niklas Weber, 2024. "Computing Systemic Risk Measures with Graph Neural Networks," Papers 2410.07222, arXiv.org.
    13. Pang, Raymond Ka-Kay & Veraart, Luitgard Anna Maria, 2023. "Assessing and mitigating fire sales risk under partial information," Journal of Banking & Finance, Elsevier, vol. 155(C).
    14. Feinstein, Zachary & Hałaj, Grzegorz, 2023. "Interbank asset-liability networks with fire sale management," Working Paper Series 2806, European Central Bank.
    15. Zhiyu Cao & Zachary Feinstein, 2023. "Price-mediated contagion with endogenous market liquidity," Papers 2311.05977, arXiv.org, revised Sep 2024.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Zachary Feinstein, 2018. "Capital Regulation under Price Impacts and Dynamic Financial Contagion," Papers 1807.02711, arXiv.org, revised Aug 2019.
    2. Bichuch, Maxim & Feinstein, Zachary, 2022. "A repo model of fire sales with VWAP and LOB pricing mechanisms," European Journal of Operational Research, Elsevier, vol. 296(1), pages 353-367.
    3. Braouezec, Yann & Wagalath, Lakshithe, 2019. "Strategic fire-sales and price-mediated contagion in the banking system," European Journal of Operational Research, Elsevier, vol. 274(3), pages 1180-1197.
    4. Maxim Bichuch & Zachary Feinstein, 2020. "A Repo Model of Fire Sales with VWAP and LOB Pricing Mechanisms," Papers 2005.05364, arXiv.org, revised Mar 2021.
    5. Kerstin Awiszus & Agostino Capponi & Stefan Weber, 2020. "Market Efficient Portfolios in a Systemic Economy," Papers 2003.10121, arXiv.org, revised May 2021.
    6. Banerjee, Tathagata & Feinstein, Zachary, 2021. "Price mediated contagion through capital ratio requirements with VWAP liquidation prices," European Journal of Operational Research, Elsevier, vol. 295(3), pages 1147-1160.
    7. Gandy, Axel & Veraart, Luitgard A. M., 2021. "Compound poisson models for weighted networks with applications in finance," LSE Research Online Documents on Economics 104185, London School of Economics and Political Science, LSE Library.
    8. Aikman, David & Beale, Daniel & Brinley-Codd, Adam & Covi, Giovanni & Hüser, Anne‑Caroline & Lepore, Caterina, 2023. "Macroprudential stress‑test models: a survey," Bank of England working papers 1037, Bank of England.
    9. Tiziano Squartini & Guido Caldarelli & Giulio Cimini & Andrea Gabrielli & Diego Garlaschelli, 2018. "Reconstruction methods for networks: the case of economic and financial systems," Papers 1806.06941, arXiv.org.
    10. Hamed Amini & Zhongyuan Cao & Agnes Sulem, 2021. "Fire Sales, Default Cascades and Complex Financial Networks," Working Papers hal-03425599, HAL.
    11. Zhiyu Cao & Zachary Feinstein, 2023. "Price-mediated contagion with endogenous market liquidity," Papers 2311.05977, arXiv.org, revised Sep 2024.
    12. Christoph Aymanns & J. Doyne Farmer & Alissa M. Keinniejenhuis & Thom Wetzer, 2017. "Models of Financial Stability and their Application in Stress Tests," Working Papers on Finance 1805, University of St. Gallen, School of Finance.
    13. Marco Bardoscia & Paolo Barucca & Stefano Battiston & Fabio Caccioli & Giulio Cimini & Diego Garlaschelli & Fabio Saracco & Tiziano Squartini & Guido Caldarelli, 2021. "The Physics of Financial Networks," Papers 2103.05623, arXiv.org.
    14. Nils Detering & Thilo Meyer-Brandis & Konstantinos Panagiotou & Daniel Ritter, 2020. "Suffocating Fire Sales," Papers 2006.08110, arXiv.org, revised Nov 2021.
    15. Fabio Caccioli & Paolo Barucca & Teruyoshi Kobayashi, 2018. "Network models of financial systemic risk: a review," Journal of Computational Social Science, Springer, vol. 1(1), pages 81-114, January.
    16. Feinstein Zachary & El-Masri Fatena, 2017. "The effects of leverage requirements and fire sales on financial contagion via asset liquidation strategies in financial networks," Statistics & Risk Modeling, De Gruyter, vol. 34(3-4), pages 113-139, September.
    17. Covi, Giovanni & Gorpe, Mehmet Ziya & Kok, Christoffer, 2021. "CoMap: Mapping Contagion in the Euro Area Banking Sector," Journal of Financial Stability, Elsevier, vol. 53(C).
    18. Hamed Amini & Zachary Feinstein, 2020. "Optimal Network Compression," Papers 2008.08733, arXiv.org, revised Jul 2022.
    19. Barnett, William A. & Wang, Xue & Xu, Hai-Chuan & Zhou, Wei-Xing, 2022. "Hierarchical contagions in the interdependent financial network," Journal of Financial Stability, Elsevier, vol. 61(C).
    20. Carro, Adrian & Stupariu, Patricia, 2024. "Uncertainty, non-linear contagion and the credit quality channel: An application to the Spanish interbank market," Journal of Financial Stability, Elsevier, vol. 71(C).

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:ejores:v:281:y:2020:i:2:p:449-463. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/eor .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.