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Abstract
The Systemic Risk-Adjusted Liquidity (SRL) model combines option pricing with market information and balance sheet data to generate a probabilistic measure of multiple entities experiencing a liquidity event. This measure links a firm’s maturity mismatch between assets and liabilities, its overall risk profile, and the stability of its funding with those characteristics of other firms that are subject to common changes in market conditions. This approach can then be used (1) to quantify an individual institution’s time-varying contribution to expected losses from systemwide liquidity shortfalls and (2) to price contingent liquidity support during times of stress within a macroprudential framework that provides incentives for liquidity managers to internalize the negative externalities from systemic risk implications of individual funding decisions. The model also can accommodate a stress testing approach for institution-specific and/or general funding shocks that generate estimates of systemic liquidity risk (and associated charges) under adverse scenarios.
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