Liquidity and Counterparty Risks Tradeoff in Money Market Networks

Carlos León and Miguel Sarmiento ()

Borradores de Economia from Banco de la Republica de Colombia

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.

Keywords: liquidity risk; counterparty risk; network; centralization; money market (search for similar items in EconPapers)
JEL-codes: D85 E58 L14 (search for similar items in EconPapers)
Pages: 36
Date: 2016-04
New Economics Papers: this item is included in nep-mon and nep-net
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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https://doi.org/10.32468/be.936 (application/pdf)

Related works:
Working Paper: Liquidity and Counterparty Risks Tradeoff in Money Market Networks (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:bdr:borrec:936

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