1. Fiedor P., Katsoulis P. (2020). Information and Liquidity Linkages in ETFs and Underlying Markets. Research Technical Paper Series, 2020(8). Central Bank of Ireland.
We show that exchange-traded funds (ETFs) establish strong information links with the underlying equities but weak ones with the underlying corporate debt securities. This has several distinct effects on each asset class. First, ETFs propagate liquidity shocks to equities but not to debt securities. Second, ETF flows affect the underlying equities' returns to a much higher degree than debt securities' returns. Third, higher ETF ownership increases equities' volatility but decreases debt securities' volatility. The results are consistent with the view that the higher accessibility of equities facilitates the formation of close information links with ETFs through arbitrage, which makes equities' prices sensitive to ETF demand shocks and creates the potential for illiquidity contagion when this link is disrupted. In contrast, the hard-to-access nature of corporate debt securities results in weak information links with ETFs which reduces commonalities between the two markets.
Presented at: Bank of England and Central Bank of Ireland internal seminars, 2020 European Winter Meetings of the Econometric Society.
2. Casu B., Kalotychou E., Katsoulis P. (2018). Systemic Stress Testing under Central and Non-Central Clearing.
The new OTC derivatives regulatory framework expanded the role of central clearing and established the collateralization of non-centrally cleared contracts. We assess the effects of this reform on bank-level and systemic risks. By developing a stress-testing network model of the largest market participants we compare defaults due to counterparty and liquidity risks and systemic losses in the regime with and without non-central clearing. We find risk-shifting effects from counterparty to liquidity risk and reduction of systemic risk at the expense of increased contagion from central counterparties. The expansion of central clearing further reduces systemic risk, in accordance with regulatory predictions.
Presented at: IBEFA Sessions in WEAI virtual 2020 annual conference, British Accounting and Finance Association 2018 conference, Financial Engineering and Banking Society 2018 conference and European Financial Management Association 2018 conference, as well as Bank of England and Central Bank of Ireland internal seminars.
3. Katsoulis P. (2019). Systemic Liquidity Risk and Money Market Funds.
This paper examines the ability of the liquidity coverage ratio (LCR) to protect the banks against systemic liquidity risk arising from their interconnectedness with money market funds (MMFs). I develop a network model of banks (sellers) and MMFs (buyers) of money market securities and simulate MMF redemptions which can trigger asset sales and a disruption to the funding of the banks. The model is calibrated to the full holdings data of the US prime MMFs as of the end of 2017 following the introduction of the post-crisis regulations aimed at mitigating runs on MMFs and the adoption of LCR. I find that the banks can withstand the MMF funding withdrawal without breaching their LCR regulatory requirements even in the face of extreme MMF redemption shocks. The post-crisis reforms have similarly made MMFs more capable to withstand large redemptions, although they can still face severe losses if their cash is depleted and the banks are unwilling to accommodate asset sales. The results indicate that LCR can be effective from a macroprudential perspective at mitigating systemic liquidity risk.
1. Fiedor P., Katsoulis P. (2019). An Lonn Dubh: A Framework For Macroprudential Stress Testing of Investment Funds. Financial Stability Notes, 2019(2). Central Bank of Ireland.
We have developed a macroprudential stress testing framework of investment funds. This framework is a tool specifically designed to engage with the Bank’s data, and allows financial stability analysts to rapidly prototype stress tests. This enables the Bank to assess financial stability concerns within the investment funds sector in a targeted and timely manner. Further to the description of the architecture of the framework, we present the results of a baseline stress test, which acts as an initial implementation of the framework. These results show that contagion among investment funds is expected to be limited under normal market conditions. However, under heightened market illiquidity and increased investor sensitivity to fund returns we document the potential for significant spillovers and indirect contagion due to common asset holdings in the investment funds sector domiciled in Ireland.