Liquidation equilibrium with seniority and hidden CDO

Gouriéroux, Christian; Héam, Jean-Cyprien; Monfort, Alain

doi:10.1016/j.jbankfin.2013.04.016

Cited by 21 publications

(13 citation statements)

References 18 publications

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“…Eisenberg and Noe, 2001, Diebold and Yilmaz, 2011, Demange, 2011, Gouriéroux, Héam and Montfort, 2012. The main differences between these papers and ours are (1) our emphasis on deleveraging externalities (they focus on interbank contracts), and (2) the fact that our model is easily calibratable (data on interbank lending are scarce, and often not public, and the literature is mostly theoretical).…”

Section: Relation To Literature On Systemic Riskmentioning

confidence: 93%

Vulnerable Banks

Greenwood¹,

Landier²,

Thesmar³

2012

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When a bank experiences a negative shock to its equity, one way to return to target leverage is to sell assets. If asset sales occur at depressed prices, then one bank's sales may impact other banks with common exposures, resulting in contagion. We propose a simple framework that accounts for how this effect adds up across the banking sector. Our framework explains how the distribution of bank leverage and risk exposures contributes to a form of systemic risk. We compute bank exposures to system-wide deleveraging, as well as the spillover of a single bank's deleveraging onto other banks. We show how our model can be used to evaluate a variety of crisis interventions, such as mergers of good and bad banks and equity injections. We apply the framework to European banks vulnerable to sovereign risk in 2010 and 2011.

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Section: Relation To Literature On Systemic Riskmentioning

confidence: 93%

Vulnerable Banks

Greenwood¹,

Landier²,

Thesmar³

2012

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“…These differ from debt obligations because they constitute residual claims on assets after creditors have been paid, and there is no nominal limit to how much a claim is worth. Cross-holdings have network spillover effects that can be modeled by an extension of the EisenbergNoe framework that involves solving a nested pair of fixed point problems (as in Elsinger 2009 and related work by Gourieroux, Heam, and Monfort 2013). We briefly outline the argument here.…”

Section: Claims Of Different Senioritymentioning

confidence: 99%

Contagion in Financial Networks

Glasserman

Young

2015

SSRN Journal

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“…Traditionally, cascades of losses in financial networks have been studied using the Eisenberg-Noe algorithm [32] for computing a market-clearing payment vector (with losses shared proportionally), which was recently extended to multiple seniority levels [31]. The Eisenberg-Noe algorithm is economically meaningful in normal times, but as Cont et al [28] point out, the algorithm is not so reasonable for modeling an extreme event such as the default of a large bank.…”

Section: Conclusion and Discussionmentioning

confidence: 99%

Cascades in multiplex financial networks with debts of different seniority

Brummitt

Kobayashi

2015

Phys. Rev. E

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The seniority of debt, which determines the order in which a bankrupt institution repays its debts, is an important and sometimes contentious feature of financial crises, yet its impact on systemwide stability is not well understood. We capture seniority of debt in a multiplex network, a graph of nodes connected by multiple types of edges. Here an edge between banks denotes a debt contract of a certain level of seniority. Next we study cascading default. There exist multiple kinds of bankruptcy, indexed by the highest level of seniority at which a bank cannot repay all its debts. Self-interested banks would prefer that all their loans be made at the most senior level. However, mixing debts of different seniority levels makes the system more stable in that it shrinks the set of network densities for which bankruptcies spread widely. We compute the optimal ratio of senior to junior debts, which we call the optimal seniority ratio, for two uncorrelated Erdős-Rényi networks. If institutions erode their buffer against insolvency, then this optimal seniority ratio rises; in other words, if default thresholds fall, then more loans should be senior. We generalize the analytical results to arbitrarily many levels of seniority and to heavy-tailed degree distributions.

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Liquidation equilibrium with seniority and hidden CDO

Abstract: The first author gratefully acknowledges financial support of the NSERC Canada. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Autorité de Contrôle Prudentiel (ACP), nor those of the Banque de France.

Cited by 21 publications

References 18 publications

Vulnerable Banks

Vulnerable Banks

Contagion in Financial Networks

Cascades in multiplex financial networks with debts of different seniority

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