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.
|Date of creation:||May 2005|
|Date of revision:|
|Contact details of provider:|| Postal: Bank of England, Threadneedle Street, London, EC2R 8AH|
Phone: +44 (0)171 601 4030
Fax: +44 (0)171 601 5196
Web page: http://www.bankofengland.co.uk/
More information through EDIRC
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.:
- Milgrom, Paul & Roberts, John, 1994. "Comparing Equilibria," American Economic Review, American Economic Association, vol. 84(3), pages 441-59, June.
- Upper, Christian & Worms, Andreas, 2002.
"Estimating Bilateral Exposures in the German Interbank Market: Is there a Danger of Contagion?,"
Discussion Paper Series 1: Economic Studies
2002,09, Deutsche Bundesbank, Research Centre.
- Christian Upper & Andreas Worms, 2001. "Estimating bilateral exposures in the German interbank market: is there a danger of contagion?," BIS Papers chapters, in: Bank for International Settlements (ed.), Marrying the macro- and micro-prudential dimensions of financial stability, volume 1, pages 211-229 Bank for International Settlements.
- Upper, Christian & Worms, Andreas, 2004. "Estimating bilateral exposures in the German interbank market: Is there a danger of contagion?," European Economic Review, Elsevier, vol. 48(4), pages 827-849, August.
- Patricia Jackson & William Perraudin & Victoria Saporta, 2002.
"Regulatory and 'economic' solvency standards for internationally active banks,"
Bank of England working papers
161, Bank of England.
- Jackson, Patricia & Perraudin, William & Saporta, Victoria, 2002. "Regulatory and "economic" solvency standards for internationally active banks," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 953-976, May.
- Douglas W. Diamond & Raghuram G. Rajan, 2003.
"Liquidity Shortages and Banking Crises,"
NBER Working Papers
10071, National Bureau of Economic Research, Inc.
- Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania.
- Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
- C. H. Furfine, 1999. "Interbank exposures: quantifying the risk of contagion," BIS Working Papers 70, Bank for International Settlements.
- Helmut Elsinger & Alfred Lehar & Martin Summer, 2002.
"Risk Assessment for Banking Systems,"
79, Oesterreichische Nationalbank (Austrian Central Bank).
- George Sheldon & Martin Maurer, 1998. "Interbank Lending and Systemic Risk: An Empirical Analysis for Switzerland," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 134(IV), pages 685-704, December.
- Schnabel, Isabel & Shin, Hyun Song, 2002.
"Foreshadowing LTCM : the crisis of 1763,"
02-46, Sonderforschungsbreich 504.
- Schnabel, Isabel & Shin, Hyun Song, 2001. "Foreshadowing LTCM: The Crisis of 1763," Papers 02-46, Sonderforschungsbreich 504.
- Schnabel, Isabel & Shin, Hyun Song, 2001. "Foreshadowing LTCM: The Crisis of 1763," Sonderforschungsbereich 504 Publications 02-46, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
- Morris, Stephen & Shin, Hyun Song, 1999. "Risk Management with Interdependent Choice," Oxford Review of Economic Policy, Oxford University Press, vol. 15(3), pages 52-62, Autumn.
When requesting a correction, please mention this item's handle: RePEc:boe:boeewp:264. 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: (Digital Media Team)
If references are entirely missing, you can add them using this form.