The joint impact of bankruptcy costs, fire sales and cross-holdings on systemic risk in financial networks

Weber, Stefan; Weske, Kerstin

doi:10.1186/s41546-017-0020-9

Cited by 62 publications

(42 citation statements)

References 49 publications

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“…Systemic risk and financial contagion has been studied in a network of interbank payments by [12]. We refer to [20] for a review of this payment network model and extensions thereof to include, e.g., bankruptcy costs. The focus of this paper is on price-mediated contagion and fire sales.…”

Section: Introductionmentioning

confidence: 99%

Capital regulation under price impacts and dynamic financial contagion

Feinstein

2020

European Journal of Operational Research

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We construct a continuous time model for price-mediated contagion precipitated by a common exogenous stress to the banking book of all firms in the financial system. In this setting, firms are constrained so as to satisfy a risk-weight based capital ratio requirement. We use this model to find analytical bounds on the risk-weights for assets as a function of the market liquidity. Under these appropriate risk-weights, we find existence and uniqueness for the joint system of firm behavior and the asset prices. We further consider an analytical bound on the firm liquidations, which allows us to construct exact formulas for stress testing the financial system with deterministic or random stresses. Numerical case studies are provided to demonstrate various implications of this model and analytical bounds.

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Section: Introductionmentioning

confidence: 99%

Capital regulation under price impacts and dynamic financial contagion

Feinstein

2020

European Journal of Operational Research

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“…We wish to compare this model with prior notions of fire sales in the Eisenberg and Noe [2001] framework, e.g. Weber and Weske [2017]. In such works, all obligations are denominated in the same (cash) asset and illiquid assets are sold at a discount in order to cover these cash shortfalls.…”

Section: The Modelmentioning

confidence: 99%

“…If a default of node 0 were desired, this could be included by stressing the initial endowments of the n firms. We will introduce a modified version of the fictitious default algorithm from Eisenberg and Noe [2001], Rogers and Veraart [2013], Weber and Weske [2017], Amini et al [2016], Feinstein [2017] for the construction of the greatest portfolio holdings y ↑ (q) under price q ∈ R m ++ . In particular, as with the prior fictitious default algorithms, this algorithm will converge after at most n iterations since the set of defaulting banks is monotonic.…”

Section: Financial Contagion Without Market Impactsmentioning

confidence: 99%

Obligations with Physical Delivery in a Multilayered Financial Network

Feinstein¹

2019

SIAM J. Finan. Math.

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This paper provides a general framework for modeling financial contagion in a system with obligations in multiple illiquid assets (e.g., currencies). In so doing, we develop a multi-layered financial network that extends the single network of Eisenberg and Noe [2001]. In particular, we develop a financial contagion model with fire sales that allows institutions to both buy and sell assets to cover their liabilities in the different assets and act as utility maximizers.We prove that, under standard assumptions and without market impacts, equilibrium portfolio holdings exist and are unique. However, with market impacts, we prove that equilibrium portfolio holdings and market prices exist which clear the multi-layered financial system. In general, though, these clearing solutions are not unique. We extend this result by considering the tâtonnement process to find the unique attained equilibrium. The attained equilibrium need not be continuous with respect to the initial shock; these points of discontinuity match those stresses in which a financial crisis becomes a systemic crisis. We further provide mathematical formulations for payment rules and utility functions satisfying the necessary conditions for these existence and uniqueness results.We demonstrate the value of our model through illustrative numerical case studies. In particular, we study a counterfactual scenario on the event that Greece re-instituted the drachma on a dataset from the European Banking Authority.

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“…Recently, the Bank of England has extended this model to analyse solvency contagion in the UK financial system (Bardoscia et al (2017)). Multiple, extensions of this model have been developed to include effects such as • Bankruptcy costs: Elsinger (2009), Rogers and Veraart (2013), Elliott et al (2014), Glasserman and Young (2015), Weber and Weske (2017),…”

Section: Introductionmentioning

confidence: 99%

Sensitivity of the Eisenberg--Noe Clearing Vector to Individual Interbank Liabilities

Feinstein¹,

Pang²,

Rudloff³

et al. 2018

SIAM J. Finan. Math.

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We quantify the sensitivity of the Eisenberg-Noe clearing vector to estimation errors in the bilateral liabilities of a financial system. The interbank liabilities matrix is a crucial input to the computation of the clearing vector. However, in practice central bankers and regulators must often estimate this matrix because complete information on bilateral liabilities is rarely available. As a result, the clearing vector may suffer from estimation errors in the liabilities matrix. We quantify the clearing vector's sensitivity to such estimation errors and show that its directional derivatives are, like the clearing vector itself, solutions of fixed point equations. We describe estimation errors utilizing a basis for the space of matrices representing permissible perturbations and derive analytical solutions to the maximal deviations of the Eisenberg-Noe clearing vector. This allows us to compute upper bounds for the worst case perturbations of the clearing vector. Moreover, we quantify the probability of observing clearing vector deviations of a certain magnitude, for uniformly or normally distributed errors in the relative liability matrix.Applying our methodology to a dataset of European banks, we find that perturbations to the relative liabilities can result in economically sizeable differences that could lead to an underestimation of the risk of contagion. Our results are a first step towards allowing regulators to quantify errors in their simulations.

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The joint impact of bankruptcy costs, fire sales and cross-holdings on systemic risk in financial networks

Cited by 62 publications

References 49 publications

Capital regulation under price impacts and dynamic financial contagion

Capital regulation under price impacts and dynamic financial contagion

Obligations with Physical Delivery in a Multilayered Financial Network

Sensitivity of the Eisenberg--Noe Clearing Vector to Individual Interbank Liabilities

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