Models which integrate various financial stability risks are still in an early stage of development. In this paper we use the Macrofinancial Risk model (MfRisk) to construct a measure for financial stability. MfRisk applies the Merton option model in a multi-sector framework. We argue that this method satisfies the macro-prudential approach. On the basis of the MfRisk model we construct a system-wide financial stability measure for the Netherlands, which builds on the put options of the banking, insurance and pension sectors. This measure approximates the probability and the potential loss of stress in the financia l system. The measure is tested against various indicators of default risk, from which we conclude that it is a reliable proxy. Finally, it is shown how the measure can be used for stress testing.
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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number
030.
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