The effects of leverage requirements and fire sales on financial contagion via asset liquidation strategies in financial networks

Feinstein Zachary () and El-Masri Fatena ()
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Feinstein Zachary: ESE, Washington University, St. Louis, MO 63130, USA
El-Masri Fatena: Federal Deposit Insurance Corporation, Arlington, VA 22203, USA

Statistics & Risk Modeling, 2017, vol. 34, issue 3-4, 113-139

Abstract: This paper provides a framework for modeling the financial system with multiple illiquid assets when liquidation of illiquid assets is caused by failure to meet a leverage requirement. This extends the network model of [6] which incorporates a single asset with fire sales and capital adequacy ratio. This also extends the network model of [14] which incorporates multiple illiquid assets with fire sales and no leverage ratios. We prove existence of equilibrium clearing payments and liquidation prices for a known liquidation strategy when leverage requirements are required. We also prove sufficient conditions for the existence of an equilibrium liquidation strategy with corresponding clearing payments and liquidation prices. Finally, we calibrate network models to asset and liability data for 50 banks in the United States from 2007–2014 in order to draw conclusions on systemic risk as a function of leverage requirements.

Keywords: Systemic risk; financial contagion; fire sales; leverage requirements; financial network (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (4)

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DOI: 10.1515/strm-2015-0030

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