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Publication details

Are Bayesian Fan Charts Useful? The Effect of Zero Lower Bound and Evaluation of Financial Stability Stress Tests

Journal Article

Franta M., Baruník Jozef, Horváth Roman, Šmídková K.

serial: International Journal of Central Banking vol.10, 1 (2014), p. 159-187

keywords: Bayesian vector autoregression, fan chart, inflation targeting, stress tests

abstract (eng):

We show how fan charts generated from Bayesian vector autoregression models can be useful for assessing 1) the effect of the zero lower bound constraint on forecasting uncertainty and 2) the credibility of stress tests conducted to evaluate financial stability. To illustrate these issues, we use a data set for the Czech Republic and macroeconomic scenarios used by the Czech National Bank in stress tests of the banking sector. Our results demonstrate how different modeling approaches to the zero lower bound affect the resulting fan charts. The pros and cons of the considered methods are discussed; ignoring the zero lower bound constraint represents the worst approach. Next, using our fan charts, we propose a method for evaluating whether the assumptions employed in the bank’s stress tests regarding the macroeconomic outlook are sufficiently adverse and consistent with past cross-correlations observed in data. We find that CNB stress tests are sufficiently conservative in this respect.


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Institute of Information Theory and Automation