The effects of leverage requirements and fire sales on financial contagion via asset liquidation strategies in financial networks

Zachary Feinstein, Fatena El-Masri

Research output: Contribution to journalArticlepeer-review

13 Scopus citations

Abstract

This paper provides a framework for modeling the financial system with multiple illiquid assets when liquidation of illiquid assets is caused by failure to meet a leverage requirement. This extends the network model of [6] which incorporates a single asset with fire sales and capital adequacy ratio. This also extends the network model of [14] which incorporates multiple illiquid assets with fire sales and no leverage ratios. We prove existence of equilibrium clearing payments and liquidation prices for a known liquidation strategy when leverage requirements are required. We also prove sufficient conditions for the existence of an equilibrium liquidation strategy with corresponding clearing payments and liquidation prices. Finally, we calibrate network models to asset and liability data for 50 banks in the United States from 2007-2014 in order to draw conclusions on systemic risk as a function of leverage requirements.

Original languageEnglish
Pages (from-to)113-139
Number of pages27
JournalStatistics and Risk Modeling
Volume34
Issue number3-4
DOIs
StatePublished - 1 Sep 2017

Keywords

  • Systemic risk
  • financial contagion
  • financial network
  • fire sales
  • leverage requirements

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