Stress Testing German Industry Sectors: Results from a Vine Copula Based Quantile Regression

Abstract

Abstract:Measuring interdependence between probabilities of default (PDs) in different industry sectors of an economy plays a crucial role in financial stress testing. Thereby, regression approaches may be employed to model the impact of stressed industry sectors as covariates on other response sectors. We identify vine copula based quantile regression as an eligible tool for conducting such stress tests as this method has good robustness properties, takes into account potential nonlinearities of conditional quantile functions and ensures that no quantile crossing effects occur. We illustrate its performance by a data set of sector specific PDs for the German economy. Empirical results are provided for a rough and a fine-grained industry sector classification scheme. Amongst others, we confirm that a stressed automobile industry has a severe impact on the German economy as a whole at different quantile levels whereas, e.g., for a stressed financial sector the impact is rather moderate. Moreover, the vine copula based quantile regression approach is benchmarked against both classical linear quantile regression and expectile regression in order to illustrate its methodological effectiveness in the scenarios evaluated.

Risk Measurement and Risk Modelling Using Applications of Vine Copulas

“…Geidosch and Fisher (2016) [19] show the superiority of vine copulas over conventional copulas when modeling the dependence structure of a credit portfolio. Fischer et al [20] use vine copula based quantile regression to stress testing German industry sectors.…”