How Does Failure Spread Across Broker-Dealers and Dealer Banks?

44 Pages Posted: 18 Jul 2014

See all articles by Jefferson Duarte

Jefferson Duarte

Rice University

Adam C. Kolasinski

Texas A&M University - Department of Finance

Date Written: July 16, 2014

Abstract

We empirically test for the presence of two types of financial contagion across large broker-dealers and dealer banks during the crisis of 2007-2009: the type based on the idea that market illiquidity mediates the spread of distress from one dealer to others, or, “liquidity contagion”, and the type based on the idea that one dealer’s distress directly undermines the franchise value of others, or, “franchise value contagion”. We test for the two types of contagion against the null hypothesis that correlation in dealer-distress during the crisis was only due to an observable common shock to the real estate assets that triggered the crisis. We find evidence that prior to the Federal Reserve and Treasury market interventions in the Fall of 2008, both types of contagion were present. Franchise-value contagion, however, dominates, accounting for 95% of all contagion. Furthermore, unlike liquidity contagion which disappears after the interventions are in place, franchise-value contagion remains.

Keywords: Contagion, Financial Crisis, Banking Crises, Funding Liquidity, Market Liquidity, Broker-Dealers, Subprime

JEL Classification: E58, E65, G21, G24, G28

Suggested Citation

Duarte, Jefferson and Kolasinski, Adam C., How Does Failure Spread Across Broker-Dealers and Dealer Banks? (July 16, 2014). Available at SSRN: https://ssrn.com/abstract=2467109 or http://dx.doi.org/10.2139/ssrn.2467109

Jefferson Duarte

Rice University ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States
713.3486137 (Phone)

Adam C. Kolasinski (Contact Author)

Texas A&M University - Department of Finance ( email )

360 Wehner
College Station, TX 77843-4218
United States

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