Researchers from the Bank of England and University College London study the impact of common asset holdings across different financial sectors on financial stability. In particular, they model indirect contagion via fire sales across UK banks and non-banks.
Fire sales are triggered by different responses to a financial shock: banks and non unit-linked insurers are subject to regulatory constraints, while funds and unit-linked insurers are obliged to meet investor redemptions. They use their model to conduct a systemic stress simulation under different initial shock scenarios and institutions’ selling strategies.
Researchers find that performing a stress simulation that does not account for common asset holdings across multiple sectors can severely underestimate the fire sale losses in the financial system.