Finance Seminar（2014-24）

Topic:Systemic Risk and Market Liquidity

Speaker:Kebin Ma, Warwick Business School

Time:Wednesday, 30 July, 10:00-11:30

Location:Room 217,Guanghua Building 2

Abstract:This paper studies a model where investors’ systemic risk-taking is driven by their need for market liquidity. By investing in the same asset of systemic risk, investors can expect homogeneous returns and thereby limit their private information on asset qualities. This mitigates adverse selection and fosters asset liquidity. Such liquidity creation, however, results in systemic risk: When the asset experiences a loss, all investors become stressed at the same time. Herding therefore presents a trade-off between systemic risk and liquidity creation. The model also suggests that systemic risk and leverage are mutually reinforcing: Investing in a systemic-but-liquid asset increases collateral value and debt capacity. Moreover, investors leveraged with short-term debt will find the systemic-but-liquid asset attractive for reducing the risk of runs. The paper offers an explanation of why banks collectively exposed themselves to mortgage-backed securities prior to the crisis, and why the exposure grew when banks were increasingly leveraged using wholesale short-term funding.