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

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  • Prüser, Jan
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.

Suggested Citation

  • Prüser, Jan, 2021. "The horseshoe prior for time-varying parameter VARs and Monetary Policy," Journal of Economic Dynamics and Control, Elsevier, vol. 129(C).
    • Handle: RePEc:eee:dyncon:v:129:y:2021:i:c:s0165188921001238
    DOI: 10.1016/j.jedc.2021.104188
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    More about this item

    Keywords

    TVP-VAR; Global-local prior; Monetary policy;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C54 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Quantitative Policy Modeling
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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