Simulating Liquidity Stress in the Derivatives Market

31 Pages Posted: 24 Dec 2019

Date Written: December 20, 2019

Abstract

We investigate whether margin calls on derivative counterparties could exceed their available liquid assets and, by preventing immediate payment of the calls, spread such liquidity shortfalls through the market. Using trade repository data on derivative portfolios, we simulate variation margin calls in a stress scenario and compare these with the liquid-asset buffers of the institutions facing the calls. Where buffers are insufficient we assume institutions borrow additional liquidity to cover the shortfalls, but only at the last moment when payment is due. Such delays can force recipients to borrow more than otherwise, and so liquidity shortfalls can grow in aggregate as they spread through the network. However, we find an aggregate liquidity shortfall equivalent to only a small fraction of average daily cash borrowing in international repo markets. Moreover, we find that only a small part of this aggregate shortfall could be avoided if payments were co-ordinated centrally.

Keywords: financial networks, systemic risk, derivatives, central counterparties

JEL Classification: C60, G29

Suggested Citation

Bardoscia, Marco and Ferrara, Gerardo and Vause, Nicholas and Yoganayagam, Michael, Simulating Liquidity Stress in the Derivatives Market (December 20, 2019). Bank of England Working Paper No. 838, December 2019, Available at SSRN: https://ssrn.com/abstract=3508655 or http://dx.doi.org/10.2139/ssrn.3508655

Marco Bardoscia (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Gerardo Ferrara

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Nicholas Vause

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Michael Yoganayagam

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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