[go: up one dir, main page]
IDEAS home Printed from https://ideas.repec.org/a/col/000107/007512.html
   My bibliography  Save this article

A Market Risk Approach to Liquidity Risk and Financial Contagion

Author

Listed:
  • Dairo Estrada
  • Daniel Osorio
Abstract
According to traditional literature, liquidity risk in individual banks can turn into a wide-system financial crisis when either interbank credit exposures or bank runs are present. This paper shows that this phenomenon can also arise when individual liquidity risk transforms into wide-system marketrisk (even in the absence of bank runs and interbank credit networks). This happens when banks try to sell some portion of its assets in order to overcome a liquidity shortage (individual liquidity risk). These sales depress the market price of assets if demand is not perfectly elastic. Given the fact thatbanks mark to market the asset book, the fall of market price reduces the value of assets of every bank in the system (wide-system market risk), leaving them less suited for future liquidity shortages and therefore more prone to bankruptcies. The paper rationalizes this idea through the simulation of a model that tries to capture the behavior of a liquidity manager that faces shocks on bank deposits and loans. The main results suggest that the extentof financial contagion depends crucially on the size of the market for assets.

Suggested Citation

  • Dairo Estrada & Daniel Osorio, 2006. "A Market Risk Approach to Liquidity Risk and Financial Contagion," Revista ESPE - Ensayos Sobre Política Económica, Banco de la República, vol. 24(50), pages 242-271, June.
    • Handle: RePEc:col:000107:007512
    DOI: 10.32468/Espe.5006
    as

    Download full text from publisher

    File URL: https://doi.org/10.32468/Espe.5006
    Download Restriction: no
    File URL: https://libkey.io/10.32468/Espe.5006?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
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Tsomocos, Dimitrios P., 2003. "Equilibrium analysis, banking, contagion and financial fragility," LSE Research Online Documents on Economics 24826, London School of Economics and Political Science, LSE Library.
    2. C. H. Furfine, 1999. "Interbank exposures: quantifying the risk of contagion," BIS Working Papers 70, Bank for International Settlements.
    3. giulia iori and Saqib Jafarey, 2001. "Interbank Lending, reserve requirements and systemic risk," Computing in Economics and Finance 2001 63, Society for Computational Economics.
    4. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A model to analyse financial fragility," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 27(1), pages 107-142, January.
    5. Isabel Schnabel & Hyun Song Shin, 2004. "Liquidity and Contagion: The Crisis of 1763," Journal of the European Economic Association, MIT Press, vol. 2(6), pages 929-968, December.
    6. Plantin, Guillaume & Sapra, Haresh & Shin, Hyun-Song, 2005. "Marking to Market, Liquidity, and Financial Stability," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 23(S1), pages 133-155, October.
    7. repec:hal:spmain:info:hdl:2441/7a8hsseeot9659kmaedsha71l3 is not listed on IDEAS
    8. Freixas, Xavier & Parigi, Bruno M & Rochet, Jean-Charles, 2000. "Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 611-638, August.
    9. De Bandt, Olivier & Hartmann, Philipp, 2000. "Systemic risk: A survey," Working Paper Series 35, European Central Bank.
    10. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A Time Series Analysis of Financial Fragility in the UK Banking System," Annals of Finance, Springer, vol. 2(1), pages 1-21, January.
    11. Douglas W. Diamond & Raghuram G. Rajan, 2005. "Liquidity Shortages and Banking Crises," Journal of Finance, American Finance Association, vol. 60(2), pages 615-647, April.
    12. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    13. Craig H. Furfine, 1999. "Interbank exposures: quantifying the risk of contagion," Proceedings 633, Federal Reserve Bank of Chicago.
    14. Dimitrios P. Tsomocos, 2012. "Equilibrium Analysis, Banking and Financial Instability," Chapters, in: The Challenge of Financial Stability, chapter 4, pages 61-97, Edward Elgar Publishing.
    15. Goodhart, Charles A. E. & Sunirand, Pojanart & Tsomocos, Dimitrios P., 2004. "A model to analyse financial fragility: applications," Journal of Financial Stability, Elsevier, vol. 1(1), pages 1-30, September.
    16. Jean-Charles Rochet & Jean Tirole, 1996. "Interbank lending and systemic risk," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 733-765.
    17. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-781, December.
    18. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
    19. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, April.
    20. Michael Boss & Helmut Elsinger & Martin Summer & Stefan Thurner, 2004. "An Empirical Analysis of the Network Structure of the Austrian Interbank Market," Financial Stability Report, Oesterreichische Nationalbank (Austrian Central Bank), issue 7, pages 77-87.
    21. 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.
    22. Hasan, Iftekhar & Dwyer, Gerald P, Jr, 1994. "Bank Runs in the Free Banking Period," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(2), pages 271-288, May.
    23. 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.
    24. Castiglionesi, Fabio, 2007. "Financial contagion and the role of the central bank," Journal of Banking & Finance, Elsevier, vol. 31(1), pages 81-101, January.
    25. Franklin Allen & Douglas Gale, 2003. "Financial Fragility, Liquidity and Asset Prices," Center for Financial Institutions Working Papers 01-37, Wharton School Center for Financial Institutions, University of Pennsylvania.
    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. Camilo González Sabogal, 2014. "Un mecanismo para lograr la participación de los bancos en los mercados interbancarios no colateralizados," Revista ESPE - Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 32(73), pages 17-35, July.
    2. Wilmar Cabrera & Adriana María Corredor-Waldron & Carlos Quicazán, 2012. "Requerimientos Macroprudenciales de capital y riesgo sistémico: Una aplicación para Colombia," Temas de Estabilidad Financiera 074, Banco de la Republica de Colombia.
    3. Orlando Rivera-Escobar & John Willmer Escobar & Diego Fernando Manotas, 2022. "Measurement of Systemic Risk in the Colombian Banking Sector," Risks, MDPI, vol. 10(1), pages 1-27, January.

    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. repec:bdr:ensayo:v::y:2006:i:50:p:242-271 is not listed on IDEAS
    2. Claudio Borio, 2011. "Rediscovering the Macroeconomic Roots of Financial Stability Policy: Journey, Challenges, and a Way Forward," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 87-117, December.
    3. Claudio Borio & Mathias Drehmann, 2011. "Toward an Operational Framework for Financial Stability: “Fuzzy” Measurement and Its Consequences," Central Banking, Analysis, and Economic Policies Book Series, in: Rodrigo Alfaro (ed.),Financial Stability, Monetary Policy, and Central Banking, edition 1, volume 15, chapter 4, pages 063-123, Central Bank of Chile.
    4. Acharya, Viral & Yorulmazer, Tanju, 2003. "Information Contagion and Inter-Bank Correlation in a Theory of Systemic Risk," CEPR Discussion Papers 3743, C.E.P.R. Discussion Papers.
    5. Iman van Lelyveld & Franka Liedorp, 2006. "Interbank Contagion in the Dutch Banking Sector: A Sensitivity Analysis," International Journal of Central Banking, International Journal of Central Banking, vol. 2(2), May.
    6. Augusto Hasman, 2013. "A Critical Review Of Contagion Risk In Banking," Journal of Economic Surveys, Wiley Blackwell, vol. 27(5), pages 978-995, December.
    7. Lelyveld, Iman van & Liedorp, Franka, 2004. "Interbank Contagion in the Dutch Banking Sector," MPRA Paper 651, University Library of Munich, Germany, revised 11 Jul 2005.
    8. Sudipto Bhattacharya & Pojanart Sunirand, 2012. "Banks, Relative Performance, and Sequential Contagion," Chapters, in: The Challenge of Financial Stability, chapter 7, pages 153-170, Edward Elgar Publishing.
    9. Ebrahimi Kahou, Mahdi & Lehar, Alfred, 2017. "Macroprudential policy: A review," Journal of Financial Stability, Elsevier, vol. 29(C), pages 92-105.
    10. Claudio Borio, 2003. "Towards a Macroprudential Framework for Financial Supervision and Regulation?," CESifo Economic Studies, CESifo Group, vol. 49(2), pages 181-215.
    11. Martin Summer, 2003. "Banking Regulation and Systemic Risk," Open Economies Review, Springer, vol. 14(1), pages 43-70, January.
    12. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2007. "Network models and financial stability," Journal of Economic Dynamics and Control, Elsevier, vol. 31(6), pages 2033-2060, June.
    13. Skeie, David R., 2008. "Banking with nominal deposits and inside money," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 562-584, October.
    14. Devriese, Johan & Mitchell, Janet, 2006. "Liquidity risk in securities settlement," Journal of Banking & Finance, Elsevier, vol. 30(6), pages 1807-1834, June.
    15. Silva, Walmir & Kimura, Herbert & Sobreiro, Vinicius Amorim, 2017. "An analysis of the literature on systemic financial risk: A survey," Journal of Financial Stability, Elsevier, vol. 28(C), pages 91-114.
    16. Rajkamal Iyer & José-Luis Peydró, 2011. "Interbank Contagion at Work: Evidence from a Natural Experiment," The Review of Financial Studies, Society for Financial Studies, vol. 24(4), pages 1337-1377.
    17. Xavier Freixas & Bruno Maria Parigi, 2008. "Lender of Last Resort and Bank Closure Policy," CESifo Working Paper Series 2286, CESifo.
    18. Grégory Nguyen, 2003. "The Belgian Interbank Market: Interbank Linkages and Systemic Risk," Financial Stability Review, National Bank of Belgium, vol. 1(1), pages 105-123, June.
    19. Mistrulli, Paolo Emilio, 2011. "Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1114-1127, May.
    20. Goodhart, C.A.E. & Sunirand, P. & Tsomocos, D.P., 2011. "The optimal monetary instrument for prudential purposes," Journal of Financial Stability, Elsevier, vol. 7(2), pages 70-77, June.
    21. Georges Dionne, 2003. "The Foundationsof Banks' Risk Regulation: A Review of Literature," THEMA Working Papers 2003-46, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.

    More about this item

    Keywords

    liquidity manager; liquidity risk; market risk; systemic risk; financialcontagion; mark-to-market.;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

    Statistics

    Access and download statistics

    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:col:000107:007512. 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: Espe (email available below). General contact details of provider: https://edirc.repec.org/data/brcgvco.html .

    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.