A Repo Model of Fire Sales with VWAP and LOB Pricing Mechanisms
30 Pages Posted: 17 Nov 2020
Date Written: May 12, 2020
We consider a network of banks that optimally choose a strategy of asset liquidations and borrowing in order to cover short term obligations. The borrowing is done in the form of collateralized repurchase agreements, the haircut level of which depends on the total liquidations of all the banks. Similarly the fire-sale price of the asset obtained by each of the banks depends on the amount of assets liquidated by the bank itself and by other banks. By nature of this setup, banks’ behavior is considered as a Nash equilibrium. This paper provides two forms for market clearing to occur: through a common closing price and through an application of the limit order book. The main results of this work are providing sufficient conditions for existence and uniqueness of the clearing solutions (i.e., liquidations, borrowing, fire sale prices, and haircut levels).
Keywords: Finance, Systemic Risk, Price-Mediated Contagion, Repurchase Agreements
JEL Classification: G32
Suggested Citation: Suggested Citation