System Dynamics: When the Crash Becomes Its Own Engine

Description and use

The margin‑spiral model in Crash Simulator shows how leverage amplifies price drops and how liquidity injections can break the feedback loop.

Problem

Traditional risk models miss the self‑reinforcing nature of leveraged market crashes, leading to underestimation of tail risk.

Outcome

The simulator captures the endogeneity of crashes, showing how leverage accelerates downside and how interventions break the loop, improving risk management.

Workflow

• 1. Define state variables: price, margin‑debt stock, margin threshold.
• 2. Model iteration: price drop → equity falls below threshold → forced selling flow activates → further price drop.
• 3. Iterate until de‑leveraging or external intervention occurs.
• 4. Calibrate model using historical crash data (2008, 2020).
• 5. Use simulator to test intervention scenarios (e.g., liquidity injections).

Evidence

A crash is a process, not a point.

Source

In 2020 and 2008 rescues were not about fixing the news, they were about breaking the loop.

Source