Mastering R for Quantitative Finance

The simulation method

The best way to understand the role of a bank from a systemic point of view is to simulate the effects of its default. We can get this way the most precise results on a bank's systemic importance. Usually, the main problem with these methods is its data need. The main characteristics of individual institutions (for example, capital buffers or size) are not enough for this kind of exercise. We also have to precisely know its exposures to other banks through financial markets since the most important contagious channels are financial markets.

In this section, we will show a simple method to identify systemic importance of a financial institution. To make it as simple as possible, we have to make some assumptions:

• We will investigate ...