Liquidity and Equity Short Term Fragility: Stress Tests for the European Banking System

38 Pages Posted: 27 May 2016 Last revised: 15 May 2017

See all articles by Guillaume Arnould

Guillaume Arnould

Université Paris I Panthéon-Sorbonne - Centre d'Economie de la Sorbonne (CES); Bank of England

Catherine Bruneau

Université Paris X Nanterre; Université Paris I Panthéon-Sorbonne

Zhun Peng

University of Evry, EPEE

Date Written: April 14, 2017

Abstract

This paper assesses the resilience of Eurozone banks' equity and liquidity against large shocks to financial markets by using a CVRF model which combines copulas and factorial structures. Our analysis refers to 35 banks of the Eurozone from 2005 to 2015. Our contribution is threefold. First, we employ a model that takes into account not only the links between the assets composing banks' portfolios but we also consider second round and spillover effects between different markets and countries. We show that spillovers have notably changed over the sample period. Second, we measure the impact of different types of shocks (stock market and bond market) on bank's solvency and liquidity position and show that liquidity shortfalls are substantial, especially for banks from peripheral countries or domestic systemically important banks (D-SIB). Third, we assess the role of diversification in improving banks' resilience by examining the particular situation where stock and bond returns become positively dependent as recently observed. We show that for some banks it increases shortfalls up to 120%.

Keywords: Stress test, Financial Stability, Extreme Risks, Bank Balance Sheet, Systemic Risk, Copula, Risk factors

JEL Classification: F32, G17, G21

Suggested Citation

Arnould, Guillaume and Arnould, Guillaume and Bruneau, Catherine and Peng, Zhun, Liquidity and Equity Short Term Fragility: Stress Tests for the European Banking System (April 14, 2017). Available at SSRN: https://ssrn.com/abstract=2784664 or http://dx.doi.org/10.2139/ssrn.2784664

Guillaume Arnould (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Université Paris I Panthéon-Sorbonne - Centre d'Economie de la Sorbonne (CES) ( email )

106-112 Boulevard de l'hopital
106-112 Boulevard de l'Hôpital
Paris Cedex 13, 75647
France

Catherine Bruneau

Université Paris X Nanterre ( email )

Room G301, Building G
92001 Nanterre Cedex, 92001
France

Université Paris I Panthéon-Sorbonne ( email )

17, rue de la Sorbonne
Paris, IL 75005
France

Zhun Peng

University of Evry, EPEE ( email )

Bd. François Mitterrand
F-91025 Evry Cedex, 91028
France

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