Measuring banks’ liquidity risk: An option-pricing approach

Jinqing Zhang, Liang He and Yunbi An

Journal of Banking & Finance, 2020, vol. 111, issue C

Abstract: This paper proposes a new approach to evaluating banks’ liquidity needs, which is not only well-grounded theoretically, but is also easy to apply practically. Within the framework of a global game with imperfect information, we first establish a boundary condition for bank runs and show that there exists a unique Nash equilibrium for bank runs. Using the option-pricing approach, we then obtain a closed-form formula for the value of bank equity with both run risk and insolvency risk. Finally, a bank's optimal liquidity ratio is derived by maximizing the value of bank equity. Using data on Chinese listed banks, we show that the deviation of the actual liquidity ratio from the optimal liquidity ratio in a bank represents a robust proxy for its liquidity risk. An increased liquidity shortfall leads to worsening liquidity problems, and this is particularly pronounced when the liquidity shortfall is high.

Keywords: Bank runs; Liquidity risk; Insolvency risk; Liquidity ratio; Option pricing (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0378426619302778
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:111:y:2020:i:c:s0378426619302778

DOI: 10.1016/j.jbankfin.2019.105703

Access Statistics for this article

Journal of Banking & Finance is currently edited by Ike Mathur

More articles in Journal of Banking & Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().