Price Contagion through Balance Sheet Linkages | Hanlon Financial Systems Center

Price Contagion through Balance Sheet Linkages

Price Contagion through Balance Sheet Linkages

seminar date: 
Thursday, April 9, 2015 - 5:30pm
seminar location: 
Agostino Capponi, Assistant Professor, Columbia University

We study price linkages between assets held by financial institutions that are required to maintain fixed capital requirements over time. We consider a market consisting of a banking and nonbanking sector. Firms in the banking sector actively manage their leverage ratios to conform with pre-specified target levels. Our analysis suggests that regulatory policies aimed at stabilizing the system by imposing capital constraints on banks may have unintended consequences: banks’ deleveraging activities may amplify asset return shocks and lead to large fluctuations in realized returns. The same mechanism can cause spill-over effects, where assets held by leverage targeting banks can experience hikes or drops caused by shocks to otherwise unrelated assets held by the same banks.  Such fire-sale externalities are produced if leverage targeting banks become too large relative to the nonbanking sector, as measured by elasticity-weighted assets.  

We show that these effects can be mitigated by encouraging banks to implement asset allocation strategies with higher exposure to liquid, rather than illiquid, assets.


Agostino Capponi received his Master and Ph.D. Degree in Computer Science and Applied and Computational Mathematics from the California Institute of Technology, respectively in 2006 and 2009. He is currently an assistant professor in the IEOR Department at Columbia University, where he is also a member of the Data Science Institute.  His main research interests are in the area of financial engineering with the main focus on counterparty risk, systemic risk, and dynamic credit portfolio optimization. The outcome of his research contributes to a better understanding of risk management practices, along with their systemic implications, and to assess the impact of regulations aiming at stabilizing financial markets  His research has been published in top-tier academic journals of financial engineering, control, and signal processing, including Mathematical Finance, Finance and Stochastics, SIAM Journal of Financial Mathematics, and IEEE Transactions on Automatic Control.  His work has also been published in leading practitioner journals, such as Risk and Creditflux, and in invited book chapters.