Capital regulation under price impacts and dynamic financial contagion

Research output: Contribution to journalArticle

Abstract

We construct a continuous time model for price-mediated contagion precipitated by a common exogenous stress to the banking book of all firms in the financial system. In this setting, firms are constrained so as to satisfy a risk-weight based capital ratio requirement. We use this model to find analytical bounds on the risk-weights for assets as a function of the market liquidity. Under these appropriate risk-weights, we find existence and uniqueness for the joint system of firm behavior and the asset prices. We further consider an analytical bound on the firm liquidations, which allows us to construct exact formulas for stress testing the financial system with deterministic or random stresses. Numerical case studies are provided to demonstrate various implications of this model and analytical bounds.

Original languageEnglish (US)
Pages (from-to)449-463
Number of pages15
JournalEuropean Journal of Operational Research
Volume281
Issue number2
DOIs
StatePublished - Mar 1 2020

Fingerprint

Contagion
Liquidity
Continuous-time Model
Banking
Existence and Uniqueness
Testing
Requirements
Model
Demonstrate
Financial contagion
Price impact
Price dynamics
Capital regulation
Business
Financial system

All Science Journal Classification (ASJC) codes

  • Information Systems and Management
  • Computer Science(all)
  • Modeling and Simulation
  • Management Science and Operations Research

Cite this

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Capital regulation under price impacts and dynamic financial contagion. / Feinstein, Zachary.

In: European Journal of Operational Research, Vol. 281, No. 2, 01.03.2020, p. 449-463.

Research output: Contribution to journalArticle

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