Staff Working Paper No. 1,037
By David Aikman, Daniel Beale, Adam Brinley-Codd, Giovanni Covi, Anne‑Caroline Hüser and Caterina Lepore
We survey the rapidly developing literature on macroprudential stress‑testing models. In scope are models of contagion between banks, models of contagion within the wider financial system including non‑bank financial institutions such as investment funds, and models that emphasise the two-way interaction between the financial sector and the real economy. Our aim is twofold: first, to provide a reference guide of the state of the art for those developing such models; second, to distil insights from this endeavour for policymakers using these models. In our view, the modelling frontier faces three main challenges: (a) our understanding of the potential for amplification in sectors of the non-bank financial system during periods of stress, (b) multi-sectoral models of the non-bank financial system to analyse the behaviour of the overall demand and supply of liquidity under stress and (c) stress‑testing models that incorporate comprehensive two-way interactions between the financial system and the real economy. Emerging lessons for policymakers are that, for a given-sized shock hitting the system, its eventual impact will depend on (a) the size of financial institutions’ capital and liquidity buffers, (b) the liquidation strategies financial institutions adopt when they need to raise cash and (c) the topology of the financial network.
Macroprudential stress‑test models: a survey