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Liquidity and Counterparty Risks Tradeoff in Money Market Networks

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Abstract

We examine how liquidity is exchanged in different types of Colombian money market networks (i.e. secured, unsecured, and central bank’s repo networks). Our examination first measures and analyzes the centralization of money market networks. Afterwards, based on a simple network optimization problem between financial institutions’ mutual distances and number of connections, we examine the tradeoff between liquidity risk and counterparty risk. Empirical evidence suggests that different types of money market networks diverge in their centralization, and in how they balance counterparty risk and liquidity risk. We confirm an inverse and significant relation between counterparty risk and liquidity risk, which differs across markets in an intuitive manner. We find evidence of liquidity cross-underinsurance in secured and unsecured money markets, but they differ in their nature. Central bank’s role in mitigating liquidity risk is also supported by our results.

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  • Carlos León & Miguel Sarmiento, 2016. "Liquidity and Counterparty Risks Tradeoff in Money Market Networks," Borradores de Economia 936, Banco de la Republica de Colombia.
    • Handle: RePEc:bdr:borrec:936
    DOI: 10.32468/be.936
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    Cited by:

    1. Freddy Cepeda-López & Fredy Gamboa-Estrada & Carlos León & Hernán Rincón-Castro, 2019. "The evolution of world trade from 1995 to 2014: A network approach," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 28(4), pages 452-485, May.
    2. Miguel Sarmiento, 2019. "The Impact of Exogenous Liquidity Shocks on Banks Funding Costs: Microevidence from the Unsecured Interbank Market," IHEID Working Papers 01-2019, Economics Section, The Graduate Institute of International Studies.
    3. Zhang, Simpson & van der Schaar, Mihaela, 2020. "Reputational dynamics in financial networks during a crisis," Journal of Financial Stability, Elsevier, vol. 49(C).
    4. Ortega, Fabio & León, Carlos, 2018. "Las transferencias procesadas por ACH Colombia: un análisis desde la perspectiva de topología de redes," Revista Lecturas de Economía, Universidad de Antioquia, CIE, issue 88, pages 109-153, January.
    5. Miguel Sarmiento, 2016. "Market Discipline and Liquidity Risk: Evidence from the Interbank Funds Market," IHEID Working Papers 14-2016, Economics Section, The Graduate Institute of International Studies.
    6. Fabio Ortega & Carlos León, 2018. "Transfers processed by ACH Colombia: a network topology analysis," Lecturas de Economía, Universidad de Antioquia, Departamento de Economía, issue 88, pages 109-153, Enero - J.
    7. Ricardo Mariño-Martínez & Carlos León & Carlos Cadena-Silva, 2020. "Las entidades de contrapartida central en la mitigación del riesgo de contraparte y de liquidez: El caso de los derivados cambiarios en Colombia," Borradores de Economia 1101, Banco de la Republica de Colombia.
    8. Carlos León & Javier Miguélez, 2020. "Interbank relationship lending in Colombia," Borradores de Economia 1118, Banco de la Republica de Colombia.
    9. Cepeda, Fredy & Gamboa, Freddy & León, C. & Rincon, Hernan, 2017. "The Evolution of World Trade from 1995 to 2014 : A Network Approach," Other publications TiSEM f20d3dc2-d624-4dd8-9c47-5, Tilburg University, School of Economics and Management.
    10. Fabio Ortega & Carlos León, 2017. "Las transferencias compensadas por ACH Colombia: Un análisis desde la perspectiva de topología de redes," Borradores de Economia 990, Banco de la Republica de Colombia.

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    More about this item

    Keywords

    liquidity risk; counterparty risk; network; centralization; money market;
    All these keywords.

    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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