Anatomy of the Repo Rate Spikes in September 2019

Repurchase agreement (repo) markets represent one of the largest sources of funding and risk transformation in the US financial system. Despite the large volume, repo rates can be quite volatile, and in the extreme, they have exhibited intraday spikes that are five to 10 times the rate on a typical day. This paper uses a unique combination of intraday timing data from the repo market to examine the potential causes of the dramatic spike in repo rates in mid-September 2019. We conclude that, in large part, the spike resulted from a confluence of factors that, when taken individually, would not have been nearly as disruptive. Our work highlights how a lack of information transmission across repo segments and stickiness in customer-to-dealer markets most likely exacerbated the spike. These findings are instructive in the context of repo market liquidity, demonstrating how the segmented structure of the market can contribute to its fragility

An agent-based approach to interbank market lending decisions and risk implications

In this study, we examine the relationship of bank level lending and borrowing decisions and the risk preferences on the dynamics of the interbank lending market. We develop an agent-based model that incorporates individual bank decisions using the temporal difference reinforcement learning algorithm with empirical data of 6600 U.S. banks. The model can successfully replicate the key characteristics of interbank lending and borrowing relationships documented in the recent literature. A key finding of this study is that risk preferences at the individual bank level can lead to unique interbank market structures that are suggestive of the capacity with which the market responds to surprising shocks

Interbank contagion: an agent-based model approach to endogenously formed networks

The potential impact of interconnected financial institutions on interbank financial systems is a financial stability concern for central banks and regulators. In examining how financial shocks propagate through contagion effects, we argue that endogenous individual bank choices are necessary to properly consider how losses develop as the interbank lending network evolves. We present an agent-based model to endogenously reconstruct interbank networks based on 6,600 banks' decision rules and behaviors reflected in quarterly balance sheets. We compare the results of our model to the results of a traditional stationary network framework for contagion. The model formulation reproduces dynamics similar to those of the 2007-09 financial crisis and shows how bank losses and failures arise from network contagion and lending market illiquidity. When calibrated to post-crisis data from 2011-14, the model shows the U.S. banking system has reduced its likelihood of bank failures through network contagion and illiquidity, given a similar stress scenario

How safe are central counterparties in credit default swap markets?

We propose a general framework for estimating the vulnerability to default by a central counterparty (CCP) in the credit default swaps market. Unlike conventional stress testing approaches, which estimate the ability of a CCP to withstand nonpayment by its two largest counterparties, we study the direct and indirect effects of nonpayment by members and/or their clients through the full network of exposures. We illustrate the approach for the U.S. credit default swaps market under shocks that are similar in magnitude to the Federal Reserve's stress tests. The analysis indicates that conventional stress testing approaches may underestimate the potential vulnerability of the main CCP for this market

Contagion in the CDS market

This paper analyzes counterparty exposures in the credit default swaps market and examines the impact of severe credit shocks on the demand for variation margin, which are the payments that counterparties make to offset price changes. We employ the Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) shocks and estimate their impact on the value of CDS contracts and the variation margin owed. Large and sudden demands for variation margin may exceed a firm's ability to pay, leading some firms to delay or forego payments. These shortfalls can become amplified through the network of exposures. Of particular importance in cleared markets is the potential impact on the central counterparty clearing house. Although a central node according to conventional measures of network centrality, the CCP contributes less to contagion than do several peripheral firms that are large net sellers of CDS protection. During a credit shock these firms can suffer large shortfalls that lead to further shortfalls for their counterparties, amplifying the initial shock