The horseshoe prior for time-varying parameter VARs and Monetary Policy

Jan Prüser

Journal of Economic Dynamics and Control, 2021, vol. 129, issue C

Abstract: Time-varying parameter VARs have become the workhorse models in empirical macroeconomics. These models are usually equipped with tightly parametrized prior distributions which favor a small and gradual change in parameters. Do such prior distributions suppress some degree of time variation in the VAR coefficients? We address this question by proposing a flexible global-local prior, namely the horseshoe prior. It turns out that conventional priors may suppress economically relevant patterns of time variation. Using the global-local prior, we observe that parameter change and changes in systematic monetary policy can be abrupt rather than smooth. Furthermore, we provide a comparison of the horseshoe prior with a range of plausible alternatives. Finally, we find that a VAR with a stochastic volatility specification using the horseshoe prior is well suited to modelling the extreme observations due to Covid-19. In contrast, the conventional prior (spuriously) picks up an increase of volatilities even before the Covid crisis.

Keywords: TVP-VAR; Global-local prior; Monetary policy (search for similar items in EconPapers)
JEL-codes: C11 C32 C54 E52 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:129:y:2021:i:c:s0165188921001238

DOI: 10.1016/j.jedc.2021.104188

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