Illiquidity Component of Credit Risk

14 Pages Posted: 15 Nov 2016

See all articles by Stephen Morris

Stephen Morris

Princeton University - Department of Economics

Hyun Song Shin

Bank for International Settlements (BIS)

Multiple version iconThere are 2 versions of this paper

Date Written: November 2016

Abstract

We provide a theoretical decomposition of bank credit risk into insolvency risk and illiquidity risk, defining illiquidity risk to be the counterfactual probability of failure due to a run when the bank would have survived in the absence of a run. We show that illiquidity risk is (i) decreasing in the “liquidity ratio” - the ratio of realizable cash on the balance sheet to short‐term liabilities; (ii) decreasing in the excess return of debt; and (iii) increasing in the solvency uncertainty - a measure of the variance of the asset portfolio.

Suggested Citation

Morris, Stephen Edward and Shin, Hyun Song, Illiquidity Component of Credit Risk (November 2016). International Economic Review, Vol. 57, Issue 4, pp. 1135-1148, 2016. Available at SSRN: https://ssrn.com/abstract=2869465 or http://dx.doi.org/10.1111/iere.12192

Stephen Edward Morris (Contact Author)

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

Hyun Song Shin

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

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