A0455
Title: Theory coherent shrinkage of time-varying parameters in VARs
Authors: Andrea Renzetti - Bocconi University (Italy) [presenting]
Abstract: A novel theory of coherent shrinkage prior is introduced for time-varying parameters VARs. The proposed prior can be used to sharpen inference about the time-varying parameters by leveraging on prior information from an underlying economic theory about the macroeconomic variables in the model. Exploiting prior information from conventional economic theory is revealed to form a prior for the time-varying parameters and significantly improves inference precision and forecast accuracy over the standard TVP-VAR. More specifically, using the classical 3-equation New Keynesian block to form a prior for the TVP-VAR substantially enhances forecast accuracy of output growth and of the inflation rate in a standard model of monetary policy. Additionally, prior information from economic theory can be used to address the inferential challenges faced by the standard TVP-VAR during the zero lower bound.
