Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/66960
Authors: 
O'Connor, Sean
Caldwell, Greg
Year of Publication: 
2008
Series/Report no.: 
Bank of Canada Discussion Paper 2008-13
Abstract: 
The authors examine the effect of a trade-off between shared credit risk and liquidity efficiency, among participants in Tranche 2 of the Large Value Transfer System (LVTS T2), on their decisions to leave open, or close, their bilateral credit limits (BCLs) to a participant at risk of imminent closure. The authors' analysis considers a network of three banks, in a settlement system similar to the LVTS T2. Although it is widely believed that closure of one bank is imminent, the exact timing of the closure during or after the settlement cycle is uncertain. The other two banks face an open or close choice regarding their BCLs to the problem participant. Based on the expected net payoff of each choice, which includes the value of network externalities, the analysis shows that, when the expected credit loss is sufficiently low, an open-BCL pure-strategy Nash equilibrium can exist and can be Pareto efficient. This result dispels the generality of the frequent assertion that participants in the LVTS T2 will close their BCLs to a participant that is subject to imminent closure.
Subjects: 
Financial institutions
Financial services
Payment, clearing, and settlement systems
JEL: 
G21
L13
L14
Document Type: 
Working Paper
Appears in Collections:

Files in This Item:
File
Size
313.49 kB





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.