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Margin requirements and systemic liquidity risk

Margin requirements and systemic liquidity risk
Margin requirements and systemic liquidity risk
We develop a model in which margin procyclicality and the propensity for liquidity hoarding interact to generate a systemic liquidity crisis. In this model, banks lend and borrow in the interbank market to mitigate liquidity risk and trade derivatives contracts in the OTC derivatives market to mitigate market risk. The daily mark-to-market of derivatives
contracts results in daily margin calls that banks cover using high quality liquid assets. We
find that distress due to margin procyclicality in the derivatives market can spillover to the
interbank market leading to systemic liquidity risk. Interconnectedness further amplifies the
effects of systemic risk within the interbank market. The model shows that central clearing
might increase the possibility of systemic liquidity risk due to tight margin requirements
and the timing of cash flows required from banks. We also find that haircut levels affect the
possibility of systemic liquidity risk, and highlight the potential role of a market maker of
last resort in limiting this possibility
1042-4431
78-95
Bakoush, Mohamed
09d43d33-abd2-4db0-a26a-2f5831ea0a01
Gerding, Enrico
d9e92ee5-1a8c-4467-a689-8363e7743362
Wolfe, Simon
9a2367fc-36cc-496a-bbd2-e7346bcbb19e
Bakoush, Mohamed
09d43d33-abd2-4db0-a26a-2f5831ea0a01
Gerding, Enrico
d9e92ee5-1a8c-4467-a689-8363e7743362
Wolfe, Simon
9a2367fc-36cc-496a-bbd2-e7346bcbb19e

Bakoush, Mohamed, Gerding, Enrico and Wolfe, Simon (2019) Margin requirements and systemic liquidity risk. Journal of International Financial Markets, Institutions and Money, 58, 78-95. (doi:10.1016/j.intfin.2018.09.007).

Record type: Article

Abstract

We develop a model in which margin procyclicality and the propensity for liquidity hoarding interact to generate a systemic liquidity crisis. In this model, banks lend and borrow in the interbank market to mitigate liquidity risk and trade derivatives contracts in the OTC derivatives market to mitigate market risk. The daily mark-to-market of derivatives
contracts results in daily margin calls that banks cover using high quality liquid assets. We
find that distress due to margin procyclicality in the derivatives market can spillover to the
interbank market leading to systemic liquidity risk. Interconnectedness further amplifies the
effects of systemic risk within the interbank market. The model shows that central clearing
might increase the possibility of systemic liquidity risk due to tight margin requirements
and the timing of cash flows required from banks. We also find that haircut levels affect the
possibility of systemic liquidity risk, and highlight the potential role of a market maker of
last resort in limiting this possibility

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Accepted/In Press date: 13 September 2018
e-pub ahead of print date: 14 September 2018
Published date: January 2019

Identifiers

Local EPrints ID: 423160
URI: http://eprints.soton.ac.uk/id/eprint/423160
ISSN: 1042-4431
PURE UUID: 0bf96aa0-bd89-412e-80d7-5811a6fc8eae
ORCID for Mohamed Bakoush: ORCID iD orcid.org/0000-0001-9624-9828
ORCID for Enrico Gerding: ORCID iD orcid.org/0000-0001-7200-552X
ORCID for Simon Wolfe: ORCID iD orcid.org/0000-0001-9815-9535

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Date deposited: 19 Sep 2018 16:30
Last modified: 27 Jan 2020 13:59

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Contributors

Author: Mohamed Bakoush ORCID iD
Author: Enrico Gerding ORCID iD
Author: Simon Wolfe ORCID iD

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