Stress Testing the Financial Macrocosm

Abstract

What kind of models do we need to guide us through the next crisis? If past crises are any indication, we need to explore new approaches. During the Great Financial Crisis, the models that existed at the time were of little value because they focused on firm-level interactions and did not capture the system-wide dynamics that fueled the crisis. In this paper, we sketch a vision for a new approach to understanding and mitigating financial and economic crises. We argue that next-generation stress test models must take a comprehensive a view of the financial macrocosm to enable the regulator to effectively regulate and supervise the macro-financial dynamics of the global economy.