Leveraging the network: A stress-test framework based on DebtRank

We develop a novel stress-test framework to monitor systemic risk in fin= ancial systems. The modular structure of the framework allows to accommodat= e for a variety of shock scenarios, methods to estimate interbank exposures= and mechanisms of distress propagation. The main features are as follows. = First, the framework allows to estimate and disentangle not only first-roun= d effects (i.e. shock on external assets) and second-round effects (i.e. di= stress induced in the interbank network), but also third-round effects indu= ced by possible fire sales. Second, it allows to monitor at the same time t= he impact of shocks on individual or groups of financial institutions as we= ll as their vulnerability to shocks on counterparties or certain asset clas= ses. Third, it includes estimates for loss distributions, thus combining ne= twork effects with familiar risk measures such as VaR and CVaR. Fourth, in = order to perform robustness analyses and cope with incomplete data, the fra= mework features a module for the generation of sets of networks of interban= k exposures that are coherent with the total lending and borrowing of each = bank. As an illustration, we carry out a stress-test exercise on a dataset = of listed European banks over the years 2008-2013. We find that second-roun= d and third-round effects dominate first-round effects, therefore suggestin= g that most current stress-test frameworks might lead to a severe underesti= mation of systemic risk.