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Bank solvency stress tests with fire sales

Author

Listed:
  • Breuer, Thomas
  • Summer, Martin
  • Urošević, Branko

Abstract

We present a new framework combining current methods of bank solvency stress tests with a model of fire sales. We apply the framework to the stress tests conducted by the European Banking Authority. Fire sales are described by an equilibrium model balancing leverage improvements and drops in security prices. Additional bank losses caused by fire sales are significant and go beyond the trivial fact that with fire sales we will get bigger losses. Ignoring potential fire sales effects may lead to a false sense of resilience by assuming that institutions, which are in fact fragile, are resilient.

Suggested Citation

  • Breuer, Thomas & Summer, Martin & Urošević, Branko, 2023. "Bank solvency stress tests with fire sales," Journal of Financial Stability, Elsevier, vol. 67(C).
    • Handle: RePEc:eee:finsta:v:67:y:2023:i:c:s157230892300061x
    DOI: 10.1016/j.jfs.2023.101161
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    References listed on IDEAS

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    1. Yann Braouezec & Lakshithe Wagalath, 2018. "Risk-Based Capital Requirements and Optimal Liquidation in a Stress Scenario [Testing macroprudential stress tests: the risk of regulatory risk weights]," Review of Finance, European Finance Association, vol. 22(2), pages 747-782.
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    5. Rama Cont & Lakshithe Wagalath, 2016. "Fire Sales Forensics: Measuring Endogenous Risk," Mathematical Finance, Wiley Blackwell, vol. 26(4), pages 835-866, October.
    6. Tathagata Banerjee & Zachary Feinstein, 2019. "Price mediated contagion through capital ratio requirements with VWAP liquidation prices," Papers 1910.12130, arXiv.org, revised Feb 2021.
    7. Maxim Bichuch & Zachary Feinstein, 2020. "Endogenous inverse demand functions," Papers 2012.08002, arXiv.org, revised Apr 2022.
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    9. Yann Braouezec & Lakshithe Wagalath, 2019. "Strategic fire-sales and price-mediated contagion in the banking system," Post-Print hal-02107567, HAL.
    10. Braouezec, Yann & Wagalath, Lakshithe, 2019. "Strategic fire-sales and price-mediated contagion in the banking system," European Journal of Operational Research, Elsevier, vol. 274(3), pages 1180-1197.
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    More about this item

    Keywords

    Stress testing; Fire sales; Systemic risk;
    All these keywords.

    JEL classification:

    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General
    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
    • G01 - Financial Economics - - General - - - Financial Crises
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • M48 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Government Policy and Regulation

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