Liquidity risk and contagion

Rodrigo Cifuentes, Gianluigi Ferrucci and Hyun Song Shin

Bank of England working papers from Bank of England

Abstract: 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: 2005-05
New Economics Papers: this item is included in nep-cfn, nep-cmp and nep-rmg
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Citations: View citations in EconPapers (532)

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Journal Article: Liquidity Risk and Contagion (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:264

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