Ruediger Frey | Vienna University of Economics and Business
Playing with Fire? A Mean Field Game Model for the Impact of Regulatory Capital Constraints on Fire Sales and Systemic Risk
Wednesday, April 24, 2024 h. 13:00-14:00
Sala del Consiglio
Abstract: We study the impact of regulatory capital constraints on fire sales and financial stability in a large banking system using a Mean Field Game Model for a large banking system. In our model banks are able to adjust their holdings of a risky asset via trading strategies with finite trading rate. Moreover, a bank is liquidated if it violates a regulatory capital constraint. We assume that the drift of the asset value is affected by the average change in the position of the banks in the system. In this setup banks optimize their asset holdings taking into account the distribution of the state variable and the optimal strategy other agents, which leads to a game . The problem can be translated into a system of coupled PDEs. We solve this system numerically for the case with and without capital constraints. case. We find that capital constraints alter the optimal strategy of the bank and that they can reinforce external shocks and lead to a systemic crisis, in particular if the banking system is not sufficiently well capitalized. We briefly discuss implications for macroprudential financial regulation.

