Financial stress tests that capture multiple interactions between contagion channels are conditional on specific, subjectively-imposed stress scenarios. Eigenvalue-based approaches, in contrast, provide a scenario-independent measure of systemic stability, but so far only handle a single contagion mechanism. We develop an eigenvalue-based approach that brings the best of both worlds, enabling the analysis of multiple interacting contagion channels without the need to impose a subjective stress scenario. Our model captures the solvency-liquidity nexus, which allows us to demonstrate that the instability due to interacting channels can far exceed that of the sum of the individual channels acting in isolation. The framework we develop is flexible and allows for calibration to the microstructure and contagion channels of real financial systems. Building on this framework, we derive an analytic stability criterion in the limit of a large number of institutions that gives the instability threshold as a function of the relative size and intensity of contagion channels. This analytical formula requires comparatively little data to elucidate the mechanisms that drive instability in real financial systems and thus complements the insights gained from traditional stress tests.

We use a simple agent based model of value investors in financial markets to test three credit regulation policies. The first is the unregulated case, which only imposes limits on maximum leverage. The second is Basle II and the third is a hypothetical alternative in which banks perfectly hedge all of their leverage-induced risk with options. When compared to the unregulated case both Basle II and the perfect hedge policy reduce the risk of default when leverage is low but increase it when leverage is high. This is because both regulation policies increase the amount of synchronized buying and selling needed to achieve deleveraging, which can destabilize the market. None of these policies are optimal for everyone: risk neutral investors prefer the unregulated case with low maximum leverage, banks prefer the perfect hedge policy, and fund managers prefer the unregulated case with high maximum leverage. No one prefers Basle II.