Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/123777 
Year of Publication: 
2015
Series/Report no.: 
Bank of Canada Working Paper No. 2015-32
Publisher: 
Bank of Canada, Ottawa
Abstract: 
We propose a tractable, model-based stress-testing framework where the solvency risks, funding liquidity risks and market risks of banks are intertwined. We highlight how coordination failure between a bank's creditors and adverse selection in the secondary market for the bank's assets interact, leading to a vicious cycle that can drive otherwise solvent banks to illiquidity. Investors' pessimism over the quality of a bank's assets reduces the bank's recourse to liquidity, which exacerbates the incidence of runs by creditors. This, in turn, makes investors more pessimistic, driving down other banks' recourse to liquidity. We illustrate these dynamics in a calibrated stress-testing exercise.
Subjects: 
Financial stability
Financial system regulation and policies
JEL: 
G01
G21
G28
C72
E58
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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