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SUMMARY:Modeling Financial Systemic Risk- the Network Effect and the Marke
 t Liquidity Effect - Chen\, N (Chinese University of Hong Kong)
DTSTART:20140828T104500Z
DTEND:20140828T111500Z
UID:TALK53918@talks.cam.ac.uk
CONTACT:Mustapha Amrani
DESCRIPTION:Financial institutions are interconnected directly by holding 
 debt claims against each other (the network channel)\, and they are also b
 ound by the market liquidity in selling assets to meet debt liabilities wh
 en facing distress (the liquidity channel). The goal of our study is to in
 vestigate how these two channels of risk interact to propagate individual 
 defaults to a system-wide catastrophe. We formulate the model as an optimi
 zation problem with equilibrium constraints and derive a partition algorit
 hm to solve for the market- clearing equilibrium. The solutions so obtaine
 d enables us to identify two factors\, the network multiplier and the liqu
 idity amplifier\, to characterize the contributions of these two channels 
 to financial systemic risk\, whereby we can acquire better understanding o
 f the effectiveness of several policy interventions. The analysis behind t
 he algorithm yields estimates for the contagion probability on the basis o
 f the market value of the institutions' net worths\, underscoring the impo
 rtance of equity capital as a cushion against systemic shocks in the prese
 nce of the liquidity channel. The optimization formulation also provides m
 ore structural insights to allow us to extend the study of systemic risk t
 o a system with debts of different seniorities\, and meanwhile presents a 
 close connection to the literature of stochastic networks. Finally\, we il
 lustrate the impacts of the network and the liquidity channels- in particu
 lar\, the significance of the latter -in the formation of systemic risk wi
 th data on the European banking system.\n
LOCATION:Seminar Room 1\, Newton Institute
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