TY - JOUR
T1 - Capital regulation under price impacts and dynamic financial contagion
AU - Feinstein, Zachary
N1 - Publisher Copyright:
© 2019 Elsevier B.V.
PY - 2020/3/1
Y1 - 2020/3/1
N2 - 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.
AB - 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.
KW - Finance
KW - Financial contagion
KW - Fire sales
KW - Risk-weighted assets
KW - Stress testing
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U2 - 10.1016/j.ejor.2019.08.044
DO - 10.1016/j.ejor.2019.08.044
M3 - Article
AN - SCOPUS:85071991980
SN - 0377-2217
VL - 281
SP - 449
EP - 463
JO - European Journal of Operational Research
JF - European Journal of Operational Research
IS - 2
ER -