Assessing and Mitigating Fire Sales Risk Under Partial Information

35 Pages Posted: 26 Apr 2021

See all articles by Raymond Ka-Kay Pang

Raymond Ka-Kay Pang

London School of Economics & Political Science (LSE) - Department of Mathematics

Luitgard Anna Maria Veraart

London School of Economics & Political Science (LSE) - Department of Mathematics

Date Written: April 25, 2021

Abstract

We consider the problem of assessing and mitigating fire sales risk for banks under partial information. Using data from the European Banking Authority's stress tests, we consider the matrix of asset holdings of different banks. We first analyse fire sales risk under both full and partial information using different matrix reconstruction methods. We then investigate how well some policy interventions aimed at mitigating fire sales risk perform if they are applied based on only partial information. We compare the performance of policy interventions under full and partial information. We find that even under partial information, using suitable network reconstruction methods to decide on policy interventions can significantly mitigate risk from fire sales. Furthermore, we show that some interventions based on reconstructed networks significantly outperform ad hoc methods that decide on interventions only based on the size of an institution and do not account for overlapping portfolios.

Keywords: Systemic risk, fire sales, stress testing, financial networks, matrix reconstruction, policy interventions

JEL Classification: G21, G28, G32, G33, G20

Suggested Citation

Pang, Raymond Ka-Kay and Veraart, Luitgard Anna Maria, Assessing and Mitigating Fire Sales Risk Under Partial Information (April 25, 2021). Available at SSRN: https://ssrn.com/abstract=3833975 or http://dx.doi.org/10.2139/ssrn.3833975

Raymond Ka-Kay Pang

London School of Economics & Political Science (LSE) - Department of Mathematics ( email )

Houghton Street
GB-London WC2A 2AE
United Kingdom

Luitgard Anna Maria Veraart (Contact Author)

London School of Economics & Political Science (LSE) - Department of Mathematics ( email )

Houghton Street
GB-London WC2A 2AE
United Kingdom

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