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Simulating liquidity stress in the derivatives market

Author

Listed:
  • Bardoscia, Marco

    (Bank of England)

  • Ferrara, Gerardo

    (Bank of England)

  • Vause, Nicholas

    (Bank of England)

  • Yoganayagam, Michael

    (Bank of England)

Abstract
We investigate whether margin calls on derivative counterparties could exceed their available liquid assets and, by preventing immediate payment of the calls, spread such liquidity shortfalls through the market. Using trade repository data on derivative portfolios, we simulate variation margin calls in a stress scenario and compare these with the liquid‑asset buffers of the institutions facing the calls. Where buffers are insufficient we assume institutions borrow additional liquidity to cover the shortfalls, but only at the last moment when payment is due. Such delays can force recipients to borrow more than otherwise, and so liquidity shortfalls can grow in aggregate as they spread through the network. However, we find an aggregate liquidity shortfall equivalent to only a small fraction of average daily cash borrowing in international repo markets. Moreover, we find that only a small part of this aggregate shortfall could be avoided if payments were co‑ordinated centrally.

Suggested Citation

  • Bardoscia, Marco & Ferrara, Gerardo & Vause, Nicholas & Yoganayagam, Michael, 2019. "Simulating liquidity stress in the derivatives market," Bank of England working papers 838, Bank of England.
    • Handle: RePEc:boe:boeewp:0838
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    References listed on IDEAS

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    Cited by:

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    3. David Aikman & Daniel Beale & Adam Brinley-Codd & Anne-Caroline Hüser & Giovanni Covi & Caterina Lepore, 2023. "Macro-Prudential Stress Test Models: A Survey," IMF Working Papers 2023/173, International Monetary Fund.
    4. Zema, Sebastiano Michele, 2022. "Uncovering the network structure of non-centrally cleared derivative markets: evidences from regulatory data," Working Paper Series 2721, European Central Bank.
    5. Sebastiano Michele Zema, 2023. "Uncovering the network structure of non-centrally cleared derivative markets: evidence from large regulatory data," Empirical Economics, Springer, vol. 65(4), pages 1799-1822, October.
    6. Maddalena Ghio & Linda Rousova & Dilyara Salakhova & Mr. German Villegas Bauer, 2023. "Derivative Margin Calls: A New Driver of MMF Flows," IMF Working Papers 2023/061, International Monetary Fund.
    7. 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.
    8. Cesa-Bianchi, Ambrogio & Eguren-Martin, Fernando, 2021. "Dash for dollars," Bank of England working papers 932, Bank of England.
    9. Bardoscia, Marco & Caccioli, Fabio & Gao, Haotian, 2022. "Efficiency of central clearing under liquidity stress," Bank of England working papers 1002, Bank of England.
    10. Jukonis, Audrius & Letizia, Elisa & Rousová, Linda, 2022. "The impact of derivatives collateralisation on liquidity risk: evidence from the investment fund sector," Working Paper Series 2756, European Central Bank.

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    More about this item

    Keywords

    economics;

    JEL classification:

    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other

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