Summary
A conference session on current research directions featured three papers examining market-based crises -- crises in which financial institutions are affected by shocks that propagate through asset prices and market liquidity. In these crisis models, shocks affect financial institutions through the prices of securities that the institutions hold in common. The papers open some potentially productive new avenues for research. The first paper, by Anna Pavlova of the London Business School and Roberto Rigobon of MIT, examined the transmission of shocks between countries with cross-border trade and investment. Hyun Song Shin of Princeton University examined how liquidity shocks can propagate through the linkages between balance sheets of financial institutions and securities prices. In the session's last paper, Markus Brunnermeier of Princeton University and Lasse Pedersen of New York University explored the relationship between market liquidity and funding liquidity, giving particular attention to how they interact through risk management practices at financial institutions.
See the full content of this document
Extract
Part 2: Current Trends in Economic Research On Systemic Risk
A conference session on current research directions featured three papers examining market-based crises-crises in which financial institutions are affected by shocks that propagate through asset prices and market liquidity.1 In these crisis models, shocks affect financial institutions through the prices of securities that the institutions hold in common-not through chains of connections between institutions, as in a payments network.
While market-oriented models of financial crises differ from the traditional bank-oriented models in the way shocks are propagated, they share with bank models the possibility of multiple equilibria and transitions driven by positive feedback. Thus, a shock can cause a transition from a normal state to a crisis state from which the system need not recover endogenously. Indeed, the models often feature path-dependent behavior in which the transition out of a crisis state entails a path different from the one leading to the crisis and may require some form of external intervention. The...See the full content of this document
Sponsored links
