ECB Paper Introduces Structural Quantile VAR Model for Stress Testing
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
Featured Experts

Metin Epözdemir
Metin Epözdemir helps European and African banks with design and implementation of credit risk, stress testing, capital management, and credit loss accounting solutions.

Amnon Levy
Financial researcher; authority in credit portfolio management and AI/ML, risk-based pricing, climate and credit, CECL/IFRS 9; credit and ALM

Emil Lopez
Credit risk modeling advisor; IFRS 9 researcher; data quality and risk reporting manager
Next Article
ECB Publishes Release 4.2 of BIRD DatabaseRelated Articles
EBA Finalizes Remuneration Standards for Investment Firms in EU
EBA finalized the two sets of draft regulatory technical standards on the identification of material risk-takers and on the classes of instruments used for remuneration under the Investment Firms Directive (IFD).
ECA Recommends Actions to Enhance Resolution Planning for Banks
EC published, in the Official Journal of the European Union, a notification that the European Court of Auditors (ECA) has published a special report on resolution planning in the Single Resolution Mechanism.
BoE Publishes Key Elements of the 2021 Stress Testing for Banks in UK
BoE published a scenario against which it will be stress testing banks in 2021, in addition to setting out the key elements of the 2021 stress test, guidance on the 2021 stress test, and the variable paths for the 2021 stress test.
PRA Proposes Rules on Identity Verification of Depositor Protection
PRA published a consultation paper (CP3/21) proposes rules regarding the timing of identity verification required for eligibility of depositor protection under the Financial Services Compensation Scheme (FSCS).
FSB Publishes Work Program for 2021
FSB published the work program for 2021, which reflects a strategic shift in priorities in the COVID-19 environment.
FCA Issues Update on Move to New Data Collection Platform
FCA announced that 50% firms have started using the new data collection platform RegData, which is slated to replace the existing platform known Gabriel.
Bundesbank Publishes Derivation Rules for Reporting by Banks
Bundesbank published Version 5.0 of the derivation rules for completeness check at the form level, with respect to the data quality of the European harmonized reporting system.
FED Revises Capital Planning and Stress Testing Requirements for Banks
FED finalized a rule that updates capital planning requirements to reflect the new framework from 2019 that sorts large banks into categories, with requirements that are tailored to the risks of each category.
ECB Releases Results of Bank Lending Survey for Fourth Quarter of 2020
ECB published results of the quarterly lending survey conducted on 143 banks in the euro area.
ESAs Publish Reporting Templates for Financial Conglomerates
ESAs published the final draft implementing technical standards on reporting of intra-group transactions and risk concentration of financial conglomerates subject to the supplementary supervision in EU.