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 ArticleEIOPA Submits Technical Advice on Sustainable Finance to EC
The U.S. regulators recently released baseline and severely adverse scenarios, along with other details, for stress testing the banks in 2024. The relevant U.S. banking regulators are the Federal Reserve Bank (FED), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).
The regulatory landscape for artificial intelligence (AI), including the generative kind, is evolving rapidly, with governments and regulators aiming to address the challenges and opportunities presented by this transformative technology.
The European Union (EU) has been working on the final elements of Basel III standards, with endorsement of the Banking Package and the publication of the European Banking Authority (EBA) roadmap on Basel III implementation in December 2023.
The European Financial Reporting Advisory Group (EFRAG), which plays a crucial role in shaping corporate reporting standards in European Union (EU), is seeking comments, until May 21, 2024, on the Exposure Draft ESRS for listed SMEs.
Banking regulators worldwide are increasingly focusing on addressing, monitoring, and supervising the institutions' exposure to climate and environmental risks.
The use cases of generative AI in the banking sector are evolving fast, with many institutions adopting the technology to enhance customer service and operational efficiency.
As part of the increasing regulatory focus on operational resilience, cyber risk stress testing is also becoming a crucial aspect of ensuring bank resilience in the face of cyber threats.
A few years down the road from the last global financial crisis, regulators are still issuing rules and monitoring banks to ensure that they comply with the regulations.
The European Commission (EC) recently issued an update informing that the European Council and the Parliament have endorsed the Banking Package implementing the final elements of Basel III standards
The Swiss Federal Council recently decided to further develop the Swiss Climate Scores, which it had first launched in June 2022.