City Research Online

Abstract

This thesis empirically examines the contribution of financial institutions to systemic risk by looking at their interactions with market-based finance. The financial crisis of 2007-09 catalysed the transformation of the financial system with the introduction of the post-crisis regulations, which were aimed at mitigating systemic risk by addressing vulnerabilities that manifested in the crisis. This resulted in the increased resilience of the banking sector, which was at the centre of the financial crisis, as well as the proliferation of market-based finance as an alternative source of funding for corporations. Yet, as the recent market turmoil due to Covid 19 has showcased, this has created new vulnerabilities which necessitate the continuous assessment of the evolving financial system.

The thesis is based on three essays. The first essay examines the effects of the mandatory collateralisation of over-the-counter derivatives contracts on counterparty, liquidity and systemic risks of the largest dealer banks and central counterparties (CCPs). Using a stress test network model calibrated to the banks’ balance sheet data, we document riskshifting effects in the form of risk transformation from counterparty to liquidity risk and a reduction of systemic risk at the expense of increased propensity for contagion from the CCP to its members. In addition, we find that the expansion of central clearing reduces systemic risk, in accordance with regulatory predictions.

The second essay examines the effects of exchange-traded funds (ETFs) on the underlying securities’ liquidity, returns and volatility via information links which are formed when investors use information from one asset to price the other. Using a proprietary dataset of Irish ETF holdings from the Central Bank of Ireland, we find that ETFs form close information links with the underlying equities but weak ones with the underlying corporate debt securities because of the higher accessibility of the former, leading to stronger co-movements of liquidity, returns and volatility with the equities compared to the corporate debt securities. The results indicate that ETFs can affect the underlying markets in different ways depending on their accessibility, contributing to the ongoing debate on the role of ETFs in propagating shocks and systemic risk.

Finally, the third essay examines the resilience of banks to liquidity shocks originating from money market funds (MMFs) using a stress test network model calibrated to the full US MMF holdings data, following the introduction of post-crisis regulations in both sectors. My findings suggest that while the banks can withstand a withdrawal of shortterm funding from MMFs due to their high liquidity reserves, the MMFs can incur severe fire sales losses in the face of large redemption shocks and in the absence of a regulatory authority acting as buyer of last resort of commercial paper, despite the regulations introduced to increase their resilience.

Publication Type:	Thesis (Doctoral)
Departments:	Bayes Business School Bayes Business School > Finance Bayes Business School > Bayes Business School Doctoral Theses

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