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

36 Pages Posted: 16 May 2022

See all articles by Giovanni di Iasio

Giovanni di Iasio

Bank of Italy

Spyros Alogoskoufis

European Central Bank (ECB)

Simon Kordel

European Central Bank (ECB)

Dominika Kryczka

European Central Bank (ECB)

Giulio Nicoletti

European Central Bank (ECB)

Nicholas Vause

Bank of England

Multiple version iconThere are 2 versions of this paper

Date Written: April 22, 2022

Abstract

We build a model to simulate how the euro-area market-based financial system may function under stressed conditions, such as the COVID-19 turmoil. 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 with a two-layer approach. In Layer 1, we consider the deterioration in the outlook for the nonfinancial corporate sector. Agents reallocate their portfolios and risky asset prices fall. Layer 2 adds a rating downgrade shock to Layer 1, where a fraction of investment grade nonfinancial corporate bonds is downgraded to high yield. The additional shock creates further rebalancing pressure and price movements. For both layers we present asset flows (i.e. buying and selling marketable securities) across agents and balance sheet losses. The model provides quantitative support to the equilibrium effects of the macroprudential regulation of investment funds, which we illustrate by varying their liquidity buffers.

Keywords: systemic risk, market-based finance, stress testing, covid-19

JEL Classification: G17, G21, G22, G23

Suggested Citation

di Iasio, Giovanni and Alogoskoufis, Spyros and Kordel, Simon and Kryczka, Dominika and Nicoletti, Giulio and Vause, Nicholas, A model of system-wide stress simulation: market-based finance and the Covid-19 event (April 22, 2022). Bank of Italy Occasional Paper No. 687, Available at SSRN: https://ssrn.com/abstract=4109491 or http://dx.doi.org/10.2139/ssrn.4109491

Giovanni Di Iasio (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

Spyros Alogoskoufis

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Simon Kordel

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Dominika Kryczka

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Giulio Nicoletti

European Central Bank (ECB) ( email )

Kaiserstrasse 29
Frankfurt am Main, Hessen 60311
Germany

Nicholas Vause

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
77
Abstract Views
517
Rank
479,927
PlumX Metrics