Capturing Information Contagion in a Stress-Testing Framework

29 Pages Posted: 5 Oct 2016

See all articles by Kartik Anand

Kartik Anand

Deutsche Bundesbank

Prasanna Gai

University of Auckland Business School; Australian National University (ANU); Bank of England

Celine Gauthier

Government of Canada - Bank of Canada

Moez Souissi

Government of Canada - Bank of Canada

Date Written: 2016

Abstract

We develop an operational model of information contagion and show how it may be integrated into a mainstream, top-down, stress-testing framework to quantify systemic risk. The key transmission mechanism is a two-way interaction between the beliefs of secondary market investors and the coordination failure between the creditors of financial institutions. Pessimism about macroeconomic fundamentals triggers creditor runs, but also influences the fire sale discount applied to illiquid assets by secondary market investors. This hampers a troubled bank's recourse to liquidity and increases the incidence of bank runs, potentially unleashing a wave of investor pessimism that can drive otherwise solvent banks into illiquidity. We quantify this contagion channel in the context of the Bank of Canada's model of the Canadian banking system and a stress-test scenario used by the IMF during its 2013 evaluation of the Canadian financial sector.

Keywords: liquidity risk, contagion, stress testing, global games

JEL Classification: G01, G21, G28, C72, E58

Suggested Citation

Anand, Kartik and Gai, Prasanna and Gauthier, Celine and Souissi, Moez, Capturing Information Contagion in a Stress-Testing Framework (2016). Bundesbank Discussion Paper No. 29/2016, Available at SSRN: https://ssrn.com/abstract=2848042 or http://dx.doi.org/10.2139/ssrn.2848042

Kartik Anand (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

HOME PAGE: http://www.bundesbank.de/research_kartik_anand

Prasanna Gai

University of Auckland Business School ( email )

12 Grafton Rd
Private Bag 92019
Auckland, 1010
New Zealand

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom
+020 7601 3583 (Phone)

Celine Gauthier

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

Moez Souissi

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
73
Abstract Views
493
Rank
477,924
PlumX Metrics