Estimating Financial Institutions’ Intraday Liquidity Risk: A Monte Carlo Simulation Approach

Borradores de Economia, No. 713, 2012

30 Pages Posted: 6 Jul 2012

See all articles by Carlos León

Carlos León

Tilburg University - Center for Economic Research (CentER); Financial Network Analytics Ltd

Date Written: April 1, 2012

Abstract

The most recent financial crisis unveiled that liquidity risk is far more important and intricate than regulation have conceived. The shift from bank-based to market-based financial systems and from Deferred Net Systems to liquidity-demanding Real-Time Gross Settlement of payments explains some of the shortcomings of traditional liquidity risk management.

Although liquidity regulations do exist, they still are in an early stage of development and discussion. Moreover, no all connotations of liquidity are equally addressed. Unlike market and funding liquidity, intraday liquidity has been absent from financial regulation, and has appeared only recently, after the crisis.

This paper addresses the measurement of Large-Value Payment System’s intraday liquidity risk. Based on the generation of bivariate Poisson random numbers for simulating the minute-by-minute arrival of received and executed payments, each financial institution’s intraday payments time-varying volume and degree of synchrony (i.e. timing) is modeled.

To model intraday payments’ uncertainty allows for overseeing participants’ intraday behavior; assessing their ability to fulfill intraday payments at a certain confidence level; identifying participants non-resilient to changes in payments’ timing mismatches; estimating intraday liquidity buffers. Vis-à-vis the increasing importance of liquidity risk as a source of systemic risk, and the recent regulatory amendments, results are useful for financial authorities and institutions.

Keywords: payments systems, intraday, liquidity risk, bivariate poisson process, Monte Carlo simulation, liquidity buffer, oversight

JEL Classification: C15, C63, E47, G17, D81

Suggested Citation

León, Carlos, Estimating Financial Institutions’ Intraday Liquidity Risk: A Monte Carlo Simulation Approach (April 1, 2012). Borradores de Economia, No. 713, 2012, Available at SSRN: https://ssrn.com/abstract=2101239 or http://dx.doi.org/10.2139/ssrn.2101239

Carlos León (Contact Author)

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Financial Network Analytics Ltd ( email )

London
United Kingdom

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