Backtesting Stress Tests: A Guide for M2 Forward Guidance

Kaihua Deng () and Dun Jia
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Kaihua Deng: Hanqing Advanced Institute of Economics and Finance, Renmin University of China

Annals of Economics and Finance, 2018, vol. 19, issue 2, 443-471

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.

Keywords: Cointegration; M2 components; Mean absolute error; Supervisory scenarios (search for similar items in EconPapers)
JEL-codes: E47 E58 G28 (search for similar items in EconPapers)
Date: 2018
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