Simulating fire sales in a system of banks and asset managers

We develop an agent-based model of traditional banks and asset managers to investigate the contagion risk related to fire sales and balance sheet interactions. We take a structural approach to the price formation in fire sales as in Bluhm et al. (2014) and introduce a market clearing mechanism with endogenous formation of asset prices. We find that, first, banks which are active in both the interbank and securities markets act as plague-spreaders during financial distress. Second, higher bank capital requirements may aggravate contagion by creating incentives for banks to increase exposures in the interbank market, which also leads to lower levels of a voluntary capital buffer above the minimum capital requirement. Third, asset managers absorb small liquidity shocks, but they exacerbate contagion when their voluntary liquid buffers are fully utilised. Fourth, a system with larger and more interconnected agents is more prone to contagion risk stemming from funding shocks.