System-Wide Stress Simulation

79 Pages Posted: 19 Jul 2019

See all articles by David Aikman

David Aikman

Bank of England - Monetary Assessment and Strategy Division

Pavel Chichkanov

Bank of England

Graeme Douglas

Bank of England

Yordan Georgiev

Bank of England

James Howat

Bank of England

Benjamin King

Bank of England

Date Written: July 12, 2019

Abstract

We present a model for assessing how the UK’s system of market-based finance — an increasingly important source of credit to the real economy since the financial crisis — might behave under stress. The core of this model is a set of representative agents, which correspond to key sectors of the UK’s financial system. These agents interact in asset, funding (repo), and derivatives markets and face a range of solvency and liquidity constraints on their behaviour. Our model generates ‘tipping points’ such that, if shocks are large, or if headroom relative to constraints is small, lower asset prices can cause solvency/liquidity constraints to bind, resulting in forced deleveraging and large endogenous illiquidity premia. We illustrate such an outcome via a stress scenario in which a deteriorating corporate sector outlook coincides with tighter leverage limits at key intermediaries. Our findings highlight the key role played by broker-dealers, commercial banks, investment funds and life insurers in shaping these dynamics.

Keywords: systemic risk, market-based finance, fire sales, stress testing

JEL Classification: G18, G21, G22, G23

Suggested Citation

Aikman, David and Chichkanov, Pavel and Douglas, Graeme and Georgiev, Yordan and Howat, James and King, Benjamin, System-Wide Stress Simulation (July 12, 2019). Bank of England Working Paper No. 809, July 2019, Available at SSRN: https://ssrn.com/abstract=3422874 or http://dx.doi.org/10.2139/ssrn.3422874

David Aikman (Contact Author)

Bank of England - Monetary Assessment and Strategy Division ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

Pavel Chichkanov

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Graeme Douglas

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Yordan Georgiev

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

James Howat

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Benjamin King

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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