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Liquidity Risk, Cash Flow Constraints, and Systemic Feedbacks

In: Quantifying Systemic Risk

  • Sujit Kapadia
  • Matthias Drehmann
  • John Elliott
  • Gabriel Sterne

The endogenous evolution of liquidity risk is a key driver of financial crises. This paper models liquidity feedbacks in a quantitative model of systemic risk. The model incorporates a number of channels important in the current financial crisis. As banks lose access to longer-term funding markets, their liabilities become increasingly short term, further undermining confidence. Stressed banks’ defensive actions include liquidity hoarding and asset fire sales. This behaviour can trigger funding problems at other banks and may ultimately cause them to fail. In presenting results, we analyse scenarios in which these channels of contagion operate, and conduct illustrative simulations to show how liquidity feedbacks may markedly amplify distress.

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This chapter was published in:
  • Joseph G. Haubrich & Andrew W. Lo, 2013. "Quantifying Systemic Risk," NBER Books, National Bureau of Economic Research, Inc, number haub10-1, September.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 12049.
    Handle: RePEc:nbr:nberch:12049
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    2. David Aikman & Piergiorgio Alessandri & Bruno Eklund & Prasanna Gai & Sujit Kapadia & Elizabeth Martin & Nada Mora & Gabriel Sterne & Matthew Willison, 2011. "Funding Liquidity Risk in a Quantitative Model of Systemic Stability," Central Banking, Analysis, and Economic Policies Book Series, in: Rodrigo Alfaro (ed.), Financial Stability, Monetary Policy, and Central Banking, edition 1, volume 15, chapter 12, pages 371-410 Central Bank of Chile.
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