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The Impact of Derivatives Collateralization on Liquidity Risk: Evidence from the Investment Fund Sector

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  • Audrius Jukonis
  • Elisa Letizia
  • Linda Rousova

Abstract

Stricter derivative margin requirements have increased the demand for liquid collateral, but euro area investment funds, which use derivatives extensively, have been reducing their liquid asset holdings. Using transaction-by-transaction derivatives data, we assess whether the current levels of funds’ holdings of cash and other highly liquid assets would be adequate to meet funds’ liquidity needs to cover variation margin calls on derivatives under a range of stress scenarios. The estimates indicate that between 13 percent and 33 percent of euro area funds with sizeable derivatives exposures may not have sufficient liquidity buffers to meet the calls under adverse market shocks. As a result, they are likely to redeem money market fund (MMF) shares, procyclically sell assets, and draw on credit lines, thus amplifying the market dynamics under such stress scenarios. Our findings highlight the importance of further work to assess the potential role of macroprudential policies for nonbanks, particularly regarding liquidity risk in funds.

Suggested Citation

  • Audrius Jukonis & Elisa Letizia & Linda Rousova, 2024. "The Impact of Derivatives Collateralization on Liquidity Risk: Evidence from the Investment Fund Sector," IMF Working Papers 2024/026, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2024/026
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    More about this item

    Keywords

    variation margin; EMIR data; market stress; big data; nonbank financial intermediaries; transaction-by-transaction derivatives data; derivatives collateralization; derivative margin requirements; Rescale liquidity shortfall; liquid asset holding; euro area investment funds; variation margin margin call; Liquidity risk; Mutual funds; Liquidity requirements; Liquidity; Collateral; Global;
    All these keywords.

    JEL classification:

    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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