Economics, Econometrics and Finance
4 years ago

Contagious financial failures prevented by liquidity requirements, study finds.

Journal of the European Economic Association
Liquidity Risk and Contagion
Rodrigo Cifuentes, Gianluigi Ferrucci, Hyun Song Shin

Paper Summary

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The article explores how liquidity risk in financial institutions can lead to contagious failures, especially when assets are marked to market. Distressed institutions selling assets can lower prices, triggering more sales and further price drops. Even small shocks can cause widespread failures. Liquidity requirements can help prevent these contagious failures as effectively as capital requirements.