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Adaptive models and heavy tails with an application to inflation forecasting

Davide Delle Monache () and Ivan Petrella ()

No 1603, BCAM Working Papers from Birkbeck Centre for Applied Macroeconomics

Abstract: This paper introduces an adaptive algorithm for time-varying autoregressive models in the presence of heavy tails. The evolution of the parameters is determined by the score of the conditional distribution, the resulting model is observation-driven and is estimated by classical methods. In particular, we consider time variation in both coefficients and volatility, emphasizing how the two interact with each other. Meaningful restrictions are imposed on the model parameters so as to attain local stationarity and bounded mean values. The model is applied to the analysis of inflation dynamics with the following results: allowing for heavy tails leads to significant improvements in terms of fit and forecast, and the adoption of the Student-t distribution proves to be crucial in order to obtain well calibrated density forecasts. These results are obtained using the US CPI inflation rate and are confirmed by other inflation indicators, as well as for CPI inflation of the other G7 countries.

Keywords: adaptive algorithms; inflation; score-driven models; student-t; time-varying parameters. (search for similar items in EconPapers)
JEL-codes: C22 C51 C53 E31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ecm, nep-ets, nep-for and nep-mac
Date: 2016-11
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http://www.bbk.ac.uk/ems/research/BirkCAM/working-papers/BCAM1603.pdf First version, 2016 (application/pdf)

Related works:
Journal Article: Adaptive models and heavy tails with an application to inflation forecasting (2017) Downloads
Working Paper: Adaptive models and heavy tails with an application to inflation forecasting (2016) Downloads
Working Paper: Adaptive Models and Heavy Tails with an Application to Inflation Forecasting (2016) Downloads
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