Learning from crises: A new class of time-varying parameter VARs with observable adaptation

Nicolas Hardy and Dimitris Korobilis

Working Papers from Business School - Economics, University of Glasgow

Abstract: We revisit macroeconomic time-varying parameter vector autoregressions (TVP-VARs), whose persistent coefficients may adapt too slowly to large, abrupt shifts such as those during major crises. We explore the performance of an adaptively-varying parameter (AVP) VAR that incorporates deterministic adjustments driven by observable exogenous variables, replacing latent state innovations with linear combinations of macroeconomic and financial indicators. This reformulation collapses the state equation into the measurement equation, enabling simple linear estimation of the model. Simulations show that adaptive parameters are substantially more parsimonious than conventional TVPs, effectively disciplining parameter dynamics without sacrificing flexibility. Using macroeconomic datasets for both the U.S. and the euro area, we demonstrate that AVP-VAR consistently improves out-of-sample forecasts, especially during periods of heightened volatility.

Keywords: Bayesian VAR; time-varying parameters; stochastic volatility; macroeconomic forecasting; uncertainty. (search for similar items in EconPapers)
JEL-codes: C11 C32 C53 E32 E37 (search for similar items in EconPapers)
Date: 2025-12
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