Margin Requirements and Systemic Liquidity Risk

35 Pages Posted: 16 Jan 2018

See all articles by Mohamed Bakoush

Mohamed Bakoush

University of Southampton - Southampton Business School

Enrico Gerding

University of Southampton - School of Electronics and Computer Science (ECS)

Simon Wolfe

University of Southampton - School of Management; University of Southampton - Southampton Business School

Date Written: November 10, 2017

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.

Keywords: Margin Procyclicality; Funding Liquidity Risk; Systemic Risk; Contagion; Networks; Agent-Based Modelling

JEL Classification: G01; G15; G21; G28

Suggested Citation

Bakoush, Mohamed and Gerding, Enrico and Wolfe, Simon, Margin Requirements and Systemic Liquidity Risk (November 10, 2017). Available at SSRN: https://ssrn.com/abstract=3099490 or http://dx.doi.org/10.2139/ssrn.3099490

Mohamed Bakoush (Contact Author)

University of Southampton - Southampton Business School ( email )

Southampton, SO17 1BJ
United Kingdom

Enrico Gerding

University of Southampton - School of Electronics and Computer Science (ECS) ( email )

University Road
Southampton
United Kingdom

Simon Wolfe

University of Southampton - School of Management ( email )

Highfield
Southampton S017 1BJ, Hampshire SO17 1BJ
United Kingdom

University of Southampton - Southampton Business School ( email )

Southampton, SO17 1BJ
United Kingdom

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