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Modelling fire sale contagion across banks and non-banks

Fabio Caccioli (), Gerardo Ferrara () and Amanah Ramadiah ()
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Fabio Caccioli: University College London
Amanah Ramadiah: Financial Network Analytics Ltd

No 878, Bank of England working papers from Bank of England

Abstract: We study the impact of common asset holdings across different financial sectors on financial stability. In particular, we model indirect contagion via fire sales across UK banks and non-banks. Fire sales are triggered by different responses to a financial shock: banks and non unit-linked insurers are subject to regulatory constraints, while funds and unit-linked insurers are obliged to meet investor redemptions. We use our model to conduct a systemic stress simulation under different initial shock scenarios and institutions’ selling strategies. We find that performing a stress simulation that does not account for common asset holdings across multiple sectors can severely underestimate the fire sale losses in the financial system. We also show that a pro-rata liquidation strategy would result in a higher level of fire sale losses, but a waterfall strategy may produce a higher spill over effect for a passive institution (or a passive sector) that chooses not to liquidate any of its assets during distress.

Keywords: Common asset holdings; fire sales; financial contagion; systemic risk (search for similar items in EconPapers)
JEL-codes: G20 G21 G22 G23 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2020-07-03, Revised 2021-02-18
New Economics Papers: this item is included in nep-ore
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