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

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  • Feinstein Zachary

    (ESE, Washington University, St. Louis, MO 63130, USA)

  • El-Masri Fatena

    (Federal Deposit Insurance Corporation, Arlington, VA 22203, USA)

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.

Suggested Citation

  • Feinstein Zachary & El-Masri Fatena, 2017. "The effects of leverage requirements and fire sales on financial contagion via asset liquidation strategies in financial networks," Statistics & Risk Modeling, De Gruyter, vol. 34(3-4), pages 113-139, September.
    • Handle: RePEc:bpj:strimo:v:34:y:2017:i:3-4:p:113-139:n:2
    DOI: 10.1515/strm-2015-0030
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    References listed on IDEAS

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    Cited by:

    1. Zachary Feinstein, 2018. "Capital Regulation under Price Impacts and Dynamic Financial Contagion," Papers 1807.02711, arXiv.org, revised Aug 2019.
    2. Tathagata Banerjee & Zachary Feinstein, 2018. "Impact of Contingent Payments on Systemic Risk in Financial Networks," Papers 1805.08544, arXiv.org, revised Dec 2018.
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    4. Maxim Bichuch & Zachary Feinstein, 2020. "A Repo Model of Fire Sales with VWAP and LOB Pricing Mechanisms," Papers 2005.05364, arXiv.org, revised Mar 2021.

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