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Backtesting Stress Tests: A Guide for M2 Forward Guidance

Author

Listed:
  • Kaihua Deng

    (Hanqing Advanced Institute of Economics and Finance, Renmin University of China)

  • Dun Jia

    (Hanqing Advanced Institute of Economics and Finance, Renmin University of China)

Abstract

We propose a simple procedure to gauge the reliability of a macroeconomic stress test model by positioning policy makers' projection of the economy in historical episodes that mirror the patterns of key economic variables under relevant test scenarios. The stress test model is backtested based on a weighted average measure of forecast errors. We justify the choice of scenario weights in two ways: Rational Inattention theory and calibration using historical data of economic disasters. The evaluation framework can be fruitfully applied to M2 forward guidance and is potentially valuable for Chinese monetary authorities.

Suggested Citation

  • Kaihua Deng & Dun Jia, 2018. "Backtesting Stress Tests: A Guide for M2 Forward Guidance," Annals of Economics and Finance, Society for AEF, vol. 19(2), pages 443-471, November.
    • Handle: RePEc:cuf:journl:y:2018:v:19:i:2:deng:jia
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    More about this item

    Keywords

    Cointegration; M2 components; Mean absolute error; Supervisory scenarios;
    All these keywords.

    JEL classification:

    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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