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

Giovanni di Iasio (), Spyridon Alogoskoufis, Simon Kördel, Dominika Kryczka, Giulio Nicoletti and Nicholas Vause

No 2671, Working Paper Series from European Central Bank

Abstract: We build a model to simulate how the euro area market-based financial system may function under stress. 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 in a two-layer approach. In Layer 1 the deterioration in the outlook for the corporate sector triggers portfolio reallocation by the model's agents. Layer 2 adds a rating downgrade shock where a fraction of investment grade corporate bonds is downgraded to high yield, which creates further rebalancing pressure and price movements. The model predicts (i) asset flows (buying and selling of marketable securities) across agents and (ii) balance sheet losses. It also provides quantitative evidence on equilibrium effects of the macroprudential regulation of nonbanks, which we illustrate by varying investment fund cash buffers. JEL Classification: G17, G21, G22, G23

Keywords: COVID-19; market-based finance; stress testing; systemic risk (search for similar items in EconPapers)
Date: 2022-06
New Economics Papers: this item is included in nep-ban, nep-cba, nep-eec, nep-fmk and nep-rmg
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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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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20222671

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