Stress Testing the Financial Macrocosm

Forthcoming in Handbook of Financial Stress Testing (CUP, 2022)

41 Pages Posted: 31 Aug 2021 Last revised: 2 Nov 2021

See all articles by J. Doyne Farmer

J. Doyne Farmer

University of Oxford - Institute for New Economic Thinking at the Oxford Martin School; Santa Fe Institute

Alissa M. Kleinnijenhuis

Stanford Institute for Economic Policy Research, Stanford University; Institute for New Economic Thinking at the Oxford Martin School, University of Oxford ; Oxford-Man Institute of Quantitative Finance, University of Oxford

Thom Wetzer

University of Oxford; University of Oxford, Faculty of Law; Institute for New Economic Thinking at the Oxford Martin School; University of Oxford - Oxford-Man Institute of Quantitative Finance

Date Written: August 30, 2021

Abstract

What should the next generation of financial stress tests look like? If recent crises are any guide, our strongly interlinked financial system, economy, and indeed wider society need to be viewed in unison – together, they make up a larger ‘financial macrocosm’. Studying the resilience of that larger macrocosm requires a new generation of stress testing models that capture the interconnections within the financial system, between the financial system and the real economy, and – particularly in the context of climate change – the interconnections between the natural world, the real economy, and the financial system. Such models, informed by large-scale data collection, would enable better evaluation of financial stability risks and support the design of new policy ideas to improve financial stability outcomes. In a rapidly evolving financial system that is constantly facing new threats, they would help policymakers and regulators get back into the driver’s seat. We appreciate that this vision is ambitious – the goal of this chapter is to make it plausible and to articulate what it would take to make it real. We introduce the modelling techniques and conceptual framework such an approach would be based on, outline the modelling innovations and the enabling conditions that are required, and conclude with a brief overview of the improvements to financial regulatory policy such stress tests would enable.

Keywords: Financial Stress Testing, Financial Crisis, Systemic Risk, Financial Stability, Market Ecology, Economic Simulations, Climate Stress Tests, Macroprudential Regulation, Economy-Wide Financial Stress Tests

JEL Classification: C53, C55, C67, C54, G01, G21, G23, G28, G33, P28, Q54

Suggested Citation

Farmer, J. Doyne and Kleinnijenhuis, Alissa M. and Wetzer, Thom and Wetzer, Thom, Stress Testing the Financial Macrocosm (August 30, 2021). Forthcoming in Handbook of Financial Stress Testing (CUP, 2022), Available at SSRN: https://ssrn.com/abstract=3913749 or http://dx.doi.org/10.2139/ssrn.3913749

J. Doyne Farmer

University of Oxford - Institute for New Economic Thinking at the Oxford Martin School ( email )

Eagle House
Walton Well Road
Oxford, OX2 6ED
United Kingdom

HOME PAGE: http://www.inet.ox.ac.uk/people/view/4

Santa Fe Institute ( email )

1399 Hyde Park Road
Santa Fe, NM 87501
United States
505-984-8800 (Phone)
505-982-0565 (Fax)

HOME PAGE: http://www.santafe.edu/~jdf/

Alissa M. Kleinnijenhuis (Contact Author)

Stanford Institute for Economic Policy Research, Stanford University ( email )

366 Galvez Street
John A. and Cynthia Fry Gunn Building
Stanford, CA CA 94305
United States

HOME PAGE: http://https://siepr.stanford.edu/people/alissa-kleinnijenhuis

Institute for New Economic Thinking at the Oxford Martin School, University of Oxford ( email )

Oxford
United Kingdom

Oxford-Man Institute of Quantitative Finance, University of Oxford ( email )

Oxford
United Kingdom

Thom Wetzer

University of Oxford, Faculty of Law ( email )

Oxford
United Kingdom

University of Oxford ( email )

St Cross Building
St Cross Rd
Oxford
United Kingdom

Institute for New Economic Thinking at the Oxford Martin School ( email )

Eagle House
Walton Well Road
Oxford, OX2 6ED
United Kingdom

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Oxford
United Kingdom

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