To make sure we minimise bad debts whilst maximising activity, we stress-test liquidation scenarios by simulating tail risk events on individual assets as well as on portfolios of assets to estimate bad debt risk.
Example: One asset
For instance, if our index list shows that a token jumped from 250th to 30th place and was able to maintain that position for a sufficient amount of time, we may simulate activity versus bad debts as a share of total loans given different borrow factors. As a result, we may improve the borrow factor from 0.28 to 0.35.
Example: Portfolio of assets
Alternatively, we can simulate a more complicated environment with 50 tokens from the lower quartile as borrowed assets backed uniformly by 4 collateral assets (3 of them time-tested and 1 proposed new collateral) in high volatility situations. By simulating tail risk scenarios, we can assess the worst-case scenario for the protocol and decide whether inclusion of the collateral asset is appropriate.\