A model of system-wide stress simulation: market-based finance and the Covid-19 event

Giovanni di Iasio (), Spyridon Alogoskoufis (), Simon Kordel (), Dominika Kryczka (), Giulio Nicoletti () and Nicholas Vause
Additional contact information
Spyridon Alogoskoufis: European Central Bank
Simon Kordel: European Central Bank
Dominika Kryczka: European Central Bank
Giulio Nicoletti: European Central Bank

No 687, Questioni di Economia e Finanza (Occasional Papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: We build a model to simulate how the euro-area market-based financial system may function under stressed conditions, such as the COVID-19 turmoil. The core of the model is a set of representative agents reflecting key economic sectors, which interact in asset, funding and derivatives markets and face solvency and liquidity constraints on their behaviour. We illustrate the model’s behaviour with a two-layer approach. In Layer 1, we consider the deterioration in the outlook for the nonfinancial corporate sector. Agents reallocate their portfolios and risky asset prices fall. Layer 2 adds a rating downgrade shock to Layer 1, where a fraction of investment grade nonfinancial corporate bonds is downgraded to high yield. The additional shock creates further rebalancing pressure and price movements. For both layers we present asset flows (i.e. buying and selling marketable securities) across agents and balance sheet losses. The model provides quantitative support to the equilibrium effects of the macroprudential regulation of investment funds, which we illustrate by varying their liquidity buffers.

Keywords: Systemic risk; market-based finance; stress testing; COVID-19 (search for similar items in EconPapers)
JEL-codes: G17 G21 G22 G23 (search for similar items in EconPapers)
Date: 2022-04
New Economics Papers: this item is included in nep-ban, nep-eec and nep-rmg
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Citations: View citations in EconPapers (1)

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Working Paper: A model of system-wide stress simulation: market-based finance and the Covid-19 event (2022)
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