How Severe Are the EBA Macroeconomic Scenarios for the Italian Economy? A Joint Probability Approach

Abstract

Measures of the severity of macroeconomic scenarios have been widely used in the literature, but a consistent methodology for their calculation has not been developed yet. Against this background, we provide a general method for calculating the joint probability of observing a macroeconomic scenario, which can be applied to a wide variety of structural models. By doing so, we can attach probabilities to scenarios produced with multidimensional economic models to compare their severity and plausibility. We apply our methodology to the 2016 and 2018 EBA stress test scenarios and we provide also reverse stress tests applications. Our results show that for the Italian economy both the 2016 and 2018 EBA scenarios are unlikely, especially the 2016 one. The reverse stress tests allow us to identify the key variables that affect our probabilities.

Keywords: multiple simultaneous equation models; stress tests; financial in- stability; macroprudential; joint probability

JEL Classification: C30, E30, E44, G10, G20, G28