ECB published a working paper that presents a model for forecasting and stress testing with quantile vector autoregression (VAR). The authors have developed a quantile VAR model and used it to forecast and stress test the interaction between real and financial variables in the euro area.
The paper develops the general quantile structural vector autoregressive framework. It provides the links with standard OLS structural VAR, derives the asymptotic distributions, and shows how to do forecasting with quantile structural VAR. Finally, it estimates the quantile VAR model for the euro area and performs a stress testing exercise and the counterfactual analysis before Lehman’s bankruptcy, before presenting the conclusions. Unlike standard VAR, which models only the average interaction of the endogenous variables, quantile VAR models their interaction at any quantile. The authors show how to estimate and forecast multivariate quantiles within a recursive structural system. The model is estimated using real and financial variables. The dynamic properties of the system change across quantiles. This is relevant for stress testing exercises, whose goal is to forecast the tail behavior of the economy when hit by large financial and real shocks.
Unlike OLS VAR, quantile VAR models each quantile of the distribution. This provides the natural modeling environment to design particular stress scenarios and test the impact that they have on the economy. A stress scenario is just a sequence of tail quantile shocks, which can be chosen arbitrarily by the policy maker or calibrated to mimic previous crisis episodes. The authors find the presence of strong asymmetries in the transmission of financial shocks in the euro area, with negative financial shocks being particularly harmful when coupled with negative real shocks. By modeling the average interaction between the random variables, OLS VAR models miss most of these detrimental interactions.
Related Link: Working Paper (PDF)
Keywords: Europe, EU, Banking, Insurance, Stress Testing, Modeling, Quantile VAR Model, ECB
Previous ArticleSRB Holds Annual Conference, Reflects on Turning Policy into Action
The Prudential Regulation Authority (PRA) published the final policy statement PS21/21 on the leverage ratio framework in the UK. PS21/21, which sets out the final policy of both the Financial Policy Committee (FPC) and PRA
The Consumer Financial Protection Bureau (CFPB) proposed to amend Regulation B to implement changes to the Equal Credit Opportunity Act (ECOA) under Section 1071 of the Dodd-Frank Act.
The Prudential Regulation Authority (PRA) decided to maintain, at the 2019 levels, the buffer rates for the Other Systemically Important Institutions (O-SII) for another year, with no new rates to be set until December 2023.
The Financial Stability Board (FSB) published a progress report on implementation of its high-level recommendations for the regulation, supervision, and oversight of global stablecoin arrangements.
In a letter to the authorized deposit taking institutions, the Australian Prudential Regulation Authority (APRA) announced an increase in the minimum interest rate buffer it expects banks to use when assessing the serviceability of home loan applications.
The Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) are consulting on the preliminary guidance that clarifies that stablecoin arrangements should observe international standards for payment, clearing, and settlement systems.
The European Banking Authority (EBA) and the European Insurance and Occupational Pensions Authority (EIOPA) have set out their respective work priorities for 2022.
The Malta Financial Services Authority (MFSA) updated the guidelines on supervisory reporting requirements under the reporting framework 3.0, in addition to the reporting module on leverage under the common reporting (COREP) framework.
The European Commission (EC) published the Implementing Decision 2021/1753 on the equivalence of supervisory and regulatory requirements of certain third countries and territories for the purposes of the treatment of exposures, in accordance with the Capital Requirements Regulation or CRR (575/2013).
EC published the Implementing Regulation 2021/1751, which lays down implementing technical standards on uniform formats and templates for notification of determination of the impracticability of including contractual recognition of write-down and conversion powers.