Liquidity Shocks, Market Discipline and Liquidity Risk: Evidence from the Interbank Market

Abstract We develop a model where banks invest in reserves and loans, and trade loans on the interbank market to deal with liquidity shocks. Two types of equilibria emerge, depending on the degree of credit market competition and the level of aggregate liquidity risk. In one equilibrium, all banks keep enough reserves and remain solvent. In the other, some banks default with positive probability. The latter equilibrium exists when competition is weak and large liquidity shocks are unlikely. The model delivers several implications concerning the relationship between competition, aggregate credit, and welfare.

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Liquidity Risk Sensitivity of Czech Commercial Banks

Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis ◽

10.11118/actaun201462020427 ◽

2014 ◽

Vol 62 (2) ◽

pp. 427-436

Author(s):

Pavla Vodová

Keyword(s):

Commercial Banks ◽

Banking Sector ◽

Balance Sheet ◽

Liquidity Risk ◽

Negative Influence ◽

Annual Reports ◽

Risk Sensitivity ◽

Interbank Market ◽

Liquidity Shocks ◽

The Impact

The recent financial crisis has shown that a liquidity risk plays an important role in the current developed financial system. One of the efficient tools of liquidity risk management is stress testing which can show banks their potential vulnerability to liquidity shocks. The aim of this paper is therefore to measure the liquidity risk sensitivity of Czech commercial banks and to find out the most severe scenario and the most vulnerable bank. Our sample included significant part of the Czech banking sector; we used unconsolidated balance sheet data over the period from 2000 to 2011 which were obtained from annual reports of Czech banks. We have evaluated liquidity risk of each bank in the sample via six different liquidity ratios. Then we stressed these baseline values in three stress scenarios: run on a bank (simulated by a 20% withdrawal of deposits), confidence crisis on the interbank market (simulated by a withdrawal of 20% of interbank deposits) and use of committed loans by counterparties (simulated by a 5% increase of loans provided to nonbank clients). We measured the impact of all scenarios by relative change of liquidity ratios. The impact of modelled liquidity shocks differs among scenarios. The most serious liquidity problems would be caused by the first scenario – run on a bank. The negative influence of third scenario (use of committed loans) is less severe. The confidence crisis on the interbank market would not affect bank liquidity at all. The results also show that the severity of the impact of all scenarios worsens in periods of financial distress. We have also found that large and medium sized banks are most vulnerable to liquidity shocks, mainly to massive deposit withdrawals.

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Liquidity Crunch in the Interbank Market: Is it Credit or Liquidity Risk, or Both

SSRN Electronic Journal ◽

10.2139/ssrn.1436907 ◽

2009 ◽

Cited By ~ 1

Author(s):

Angelo S. Baglioni

Keyword(s):

Liquidity Risk ◽

Interbank Market

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EUROPEAN OPTION PRICING WITH LIQUIDITY SHOCKS

International Journal of Theoretical and Applied Finance ◽

10.1142/s021902491350043x ◽

2013 ◽

Vol 16 (07) ◽

pp. 1350043 ◽

Cited By ~ 16

Author(s):

MICHAEL LUDKOVSKI ◽

QUNYING SHEN

Keyword(s):

Regime Switching ◽

Liquidity Risk ◽

Liquidity Shocks ◽

European Option Pricing ◽

Practical Guidelines ◽

Hedging Problem ◽

Equivalent Martingale ◽

Hamilton Jacobi Bellman ◽

Liquidity Shock ◽

The Impact

We study the valuation and hedging problem of European options in a market subject to liquidity shocks. Working within a Markovian regime-switching setting, we model illiquidity as the inability to trade. To isolate the impact of such liquidity constraints, we focus on the case where the market is completely static in the illiquid regime. We then consider derivative pricing using either equivalent martingale measures or exponential indifference mechanisms. Our main results concern the analysis of the semi-linear coupled Hamilton–Jacobi–Bellman (HJB) equation satisfied by the indifference price, as well as its asymptotics when the probability of a liquidity shock is small. A comparative analysis between the model price and the classical Black–Scholes benchmark is given using the concepts of implied and adjusted time to maturity. We then present several numerical studies of the liquidity risk premia obtained in our models leading to practical guidelines on how to adjust for liquidity risk in option valuation and hedging.

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