Sydow, Matthias Schilte, Aurore Covi, Giovanni Deipenbrock, Marija Del Vecchio, Leonardo Fiedor, Pawe± Fukker, Gábor Gehrend, Max Gourdel, Régis Grassi, Alberto Hilberg, Björn Kaijser, Michiel Kaoudis, Georgios Mingarelli, Luca Montagna, Mattia Piquard, Thibaut Salakhova, Dilyara Tente, Natalia
Year of Publication:
ECB Working Paper No. 2581
European Central Bank (ECB), Frankfurt a. M.
This paper shows how the combined endogenous reaction of banks and investment funds to an exogenous shock can amplify or dampen losses to the financial system compared to results from single-sector stress testing models. We build a new model of contagion propagation using a very large and granular data set for the euro area. Based on the economic shock caused by the Covid-19 outbreak, we model three sources of exogenous shocks: a default shock, a market shock and a redemption shock. Our contagion mechanism operates through a dual channel of liquidity and solvency risk. The joint modelling of banks and funds provides new insights for the assessment of financial stability risks. Our analysis reveals that adding the fund sector to our model for banks leads to additional losses through fire sales and a further depletion of banks' capital ratios by around one percentage point.
Fire sales liquidity overlapping portfolios price impact stress testing