Bank solvency stress tests with fire sales

We present a new framework combining current methods of bank solvency stress tests with a model of fire sales. We apply the framework to the stress tests conducted by the European Banking Authority. Fire sales are described by an equilibrium model balancing leverage improvements and drops in security prices. Additional bank losses caused by fire sales are significant and go beyond the trivial fact that with fire sales we will get bigger losses. Ignoring potential fire sales effects may lead to a false sense of resilience by assuming that institutions, which are in fact fragile, are resilient.