Margin requirements and systemic liquidity risk
Authored by Enrico Gerding, Mohamed Bakoush, Simon Wolfe
Date Published: 2019
DOI: 10.1016/j.intfin.2018.09.007
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Abstract
We develop a model in which margin procyclicality and the propensity for
liquidity hoarding interact to generate a systemic liquidity crisis. In
this model, banks lend and borrow in the interbank market to mitigate
liquidity risk and trade derivatives contracts in the OTC derivatives
market to mitigate market risk. The daily mark-to-market of derivatives
contracts results in daily margin calls that banks cover using high
quality liquid assets. We find that distress due to margin
procyclicality in the derivatives market can spillover to the interbank
market leading to systemic liquidity risk. Interconnectedness further
amplifies the effects of systemic risk within the interbank market. The
model shows that central clearing might increase the possibility of
systemic liquidity risk due to tight margin requirements and the timing
of cash flows required from banks. We also find that haircut levels
affect the possibility of systemic liquidity risk, and highlight the
potential role of a market maker of last resort in limiting this
possibility. (C) 2018 Elsevier B.V. All rights reserved.
Tags
Agent-based modelling
Management
networks
Systemic risk
Contagion
Fire sales
Margin procyclicality
Funding liquidity risk
Counterparty risk
Derivatives
Bad