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CCF Seminar
Andreea Minca
Cornell University
Title: Mathematical modeling of funding liquidity

Abstract: We introduce a novel game-theoretic framework for modeling funding liquidity, when lenders have heterogeneous beliefs about the future evolution of the borrower's fundamentals. We formalize the investment problem of the lenders as a coordination game and we discuss refinements of the Nash equilibrium concept, which lead to unique equilibria.

For the debt-to-asset process resulting in equilibrium, we define a notion of stability, and we characterize the entire cycle of the debt-to-asset process, or equivalently the borrower's leverage cycle. First, the debt-to-asset increases to a long-run level and is mean-reverting to that level, until it crosses an instability level. Above the instability level the debt-to-asset diverges (in expectation) and has a tendency to reach a ceiling, at which point a debt run ensues.

Crossing this instability level is the start of a deleveraging spiral and is an early indicator of a debt run. Our results are robust across a wide variety of specifications for the distribution of the lenders' capital across beliefs.

Date: Monday, March 13, 2017
Time: 4:30 pm
Location: Wean Hall 8220
Submitted by:  Steve Shreve