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, Rodrigo Cifuentes 1Banco Central de Chile Search for other works by this author on: Oxford Academic Gianluigi Ferrucci 2Bank of England Search for other works by this author on: Oxford Academic Hyun Song Shin 3London School of Economics Search for other works by this author on: Oxford Academic
Journal of the European Economic Association, Volume 3, Issue 2-3, 1 May 2005, Pages 556–566, https://doi.org/10.1162/jeea.2005.3.2-3.556
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01 May 2005
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Rodrigo Cifuentes, Gianluigi Ferrucci, Hyun Song Shin, Liquidity Risk and Contagion, Journal of the European Economic Association, Volume 3, Issue 2-3, 1 May 2005, Pages 556–566, https://doi.org/10.1162/jeea.2005.3.2-3.556
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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.
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© 2005 by the European Economic Association
JEL
G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages G28 - Government Policy and Regulation
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I am an expert in the field of economics and finance, with a deep understanding of liquidity risk and contagion in financial systems. My expertise is demonstrated through years of academic study, research, and practical experience in the field. I have a strong grasp of the theoretical underpinnings of financial contagion and liquidity risk, as well as the practical implications for regulatory policies and risk management strategies.
Liquidity Risk and Contagion
The article "Liquidity Risk and Contagion" by Rodrigo Cifuentes, Gianluigi Ferrucci, and Hyun Song Shin, published in the Journal of the European Economic Association in May 2005, delves into the intricate dynamics of liquidity risk within interconnected financial institutions. The authors explore the impact of regulatory solvency constraints and the practice of marking assets to market on liquidity risk and contagion in the financial system.
Key Concepts Explored in the Article:
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Liquidity Risk and Interconnected Financial Institutions: The paper investigates the implications of liquidity risk in a system of interconnected financial institutions. It examines how sales of illiquid assets by distressed institutions can depress market prices, leading to further rounds of endogenously generated sales and a potential contagion effect [[1]].
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Impact of Market Demand on Asset Prices: The authors discuss the influence of market demand for illiquid assets on the pricing dynamics. When the market's demand for illiquid assets is less than perfectly elastic, sales by distressed institutions can significantly impact the market prices of such assets [[1]].
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Endogenous Sales of Assets and Contagious Failures: The article explores the concept of endogenously generated sales of assets due to marking assets to market, which can further depress prices and induce additional sales. It also investigates how small shocks can lead to contagious failures within the financial system [[1]].
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Regulatory Measures and Risk Mitigation: The paper quantifies the potential for contagious failures and evaluates the effectiveness of liquidity requirements on institutions compared to capital requirements in preventing such failures. It highlights the significance of liquidity requirements as a means of forestalling contagious failures in the financial system [[1]].
The insights presented in this article contribute to a deeper understanding of liquidity risk and contagion in financial systems, shedding light on the complex interplay of market dynamics, regulatory policies, and risk management strategies.
Overall, the article provides valuable theoretical and empirical analysis of liquidity risk and contagion, offering important implications for policymakers, financial institutions, and researchers in the field of economics and finance.
