  Price-mediated contagion occurs when a positive feedback loop develops
following a drop in asset prices which forces banks and other financial
institutions to sell their holdings. Prior studies of such events fix the level
of market liquidity without regards to the level of stress applied to the
system. This paper introduces a framework to understand price-mediated
contagion in a system where the capacity of the market to absorb liquidated
assets is determined endogenously. In doing so, we construct a joint clearing
system in interbank payments, asset prices, and market liquidity. We establish
mild assumptions which guarantee the existence of greatest and least clearing
solutions. We conclude with detailed numerical case studies which demonstrate
the, potentially severe, repercussions of endogenizing the market liquidity on
system risk.
