A Model of System-Wide Stress Simulation: Market-Based Finance and the COVID-19 Event

33 Pages Posted: 29 Jun 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: June, 2022

Abstract

We build a model to simulate how the euro area market-based financial system may function under stress. 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 in a two-layer approach. In Layer 1 the deterioration in the outlook for the corporate sector triggers portfolio reallocation by the model's agents. Layer 2 adds a rating downgrade shock where a fraction of investment grade corporate bonds is downgraded to high yield, which creates further rebalancing pressure and price movements. The model predicts (i) asset flows (buying and selling of marketable securities) across agents and (ii) balance sheet losses. It also provides quantitative evidence on equilibrium effects of the macroprudential regulation of nonbanks, which we illustrate by varying investment fund cash buffers.

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

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 (June, 2022). ECB Working Paper No. 2022/2671, Available at SSRN: https://ssrn.com/abstract=4148109 or http://dx.doi.org/10.2139/ssrn.4148109

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

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