Simulating Fire-Sales in a Banking and Shadow Banking System

27 Pages Posted: 5 Nov 2020

See all articles by Susanna Calimani

Susanna Calimani

European Central Bank (ECB)

Grzegorz Hałaj

Government of Canada - Bank of Canada

Dawid Żochowski

European Central Bank

Date Written: June, 2017

Abstract

We develop an agent based model of traditional banks and asset managers. Our aim is to investigate the channels of contagion of shocks to asset prices within and between the two financial sectors, including the effects of fire sales and their impact on financial institutions’ balance sheets. We take a structural approach to the price formation mechanism as in Bluhm, Faia and Kranen (2014) and introduce a clearing mechanism with an endogenous formation of asset prices. Both types of institutions hold liquid and illiquid assets and are funded via equity and deposits. Traditional banks are interconnected in the money market via mutual interbank claims, where the rate of return is endogenously determined through a tatonnement process. We show how in such a set-up an initial exogenous liquidity shock may lead to a fire-sale spiral. Banks, which are subject to capital and liquidity requirements, may be forced to sell an illiquid security, which impacts its, endogenously determined, market price. As the price of the security decreases, both agents update their equity and adjust their balance sheets by making decisions on whether to sell or buy the security. This endogenous process may trigger a cascade of sales leading to a fire-sale. We find that, first, mixed portfolios banks act as plague-spreader in a context of financial distress. Second, higher bank capital requirements may aggravate contagion since they may incentivise banks to hold similar assets, and choose mixed portfolios business model which is also characterized by lower levels of voluntary capital buffer. Third, asset managers absorb small liquidity shocks but they exacerbate contagion when liquid buffers are fully utilised.

Keywords: agent based model, asset managers, contagion, fire sales, systemic risk

JEL Classification: C63, D85, G21, G23

Suggested Citation

Calimani, Susanna and Hałaj, Grzegorz and Żochowski, Dawid, Simulating Fire-Sales in a Banking and Shadow Banking System (June, 2017). ESRB: Working Paper Series No. 2017/46, Available at SSRN: https://ssrn.com/abstract=3723393

Susanna Calimani (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Grzegorz Hałaj

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

Dawid Żochowski

European Central Bank ( email )

Sonnemannstrasse 20
Frankfurt am Main, 60314
Germany

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