By sequentially examining the full chain of events starting from the default of firms through the fire-sale of goods towards the write-offs of bad loans, we develop a new matrix of financial transactions. This matrix is incorporated into the transactions-flows matrix of the closed economy consisting of households, firms, and banks. On the basis of the balance sheet and transactions-flows matrices, this study further constructs a stock-flow consistent model of the closed economy. We also provide the results of a numerical simulation and argue that our model allows studying how such key parameters as the probability of default, the rate of fire-sales (new injected parameter), the recovery rate, and interest rates on loans and deposits affect the performance of banks and firms, observing economic dynamics in time.
Equity Option Implied Probability of Default and Equity Recovery Rate
