Illiquidity Component of Credit Risk

Stephen Morris and Hyun Song Shin

Working Papers from Princeton University, Department of Economics, Econometric Research Program.

Abstract: We provide a theoretical decomposition of bank credit risk into insolvency risk and illiquidity risk, defining illiquidity risk to be the counterfactual probability of failure due to a run when the bank would have survived in the absence of a run. We show that illiquidity risk is (i) decreasing in the "liquidity ratio"--the ratio of realizable cash on the balance sheet to short-term liabilities; (ii) decreasing in the excess return of debt; and (iii) increasing in the solvency uncertainty--a measure of the variance of the asset portfolio.

JEL-codes: G21 G32 G33 (search for similar items in EconPapers)
Date: 2016-05
New Economics Papers: this item is included in nep-ban, nep-cfn and nep-rmg
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Citations: View citations in EconPapers (20)

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