Backtesting Distributional Forecasts in Counterparty Risk II: Empirical Results for Long Horizon Testing

Abstract

This paper provides empirical results supporting the theoretical ones by the first author on backtesting long-horizon distributional forecasts. The problem is quite general but for us it is motivated by the regulatory requirement of backtesting evolution models used in the measurement of counterparty risk. This is particularly relevant for banks that are capitalized under the IMM (internal models method) regime of the BCBS (Basel Committee on Banking Supervision). The main practical challenge there is that banks are required to backtest (forecasting) models up to horizons of at least one year. Our results give strong support to the proposed method and offers some guidelines for prudent use.