SUPR
Smooth Time Varying Parameter VARs
Dnr:

NAISS 2024/22-1607

Type:

NAISS Small Compute

Principal Investigator:

Alessandro Celani

Affiliation:

Örebro universitet

Start Date:

2024-12-06

End Date:

2026-01-01

Primary Classification:

50201: Economics

Webpage:

Allocation

Abstract

This paper introduces a novel framework designed to mitigate the overparameterization problem frequently encountered in time-varying parameter (TVP) VARs. We present a methodology grounded on the concept of "moderate time variation", where TVP are allowed to vary just over a subset of the time domain. The dimensionality reduction is performed using two ingredients: a fixed weight matrix, and a low-dimensional parameter that evolves over time. Notably, the model includes both the time-invariant VAR and the standard TVP-VAR as special cases. By using more flexible weighting schemes we allow the parameters to evolve smoothly over time. In this paper, we construct the weight matrix via B-Splines. B-Splines have both the characteristics of smoothness and "forgetting" of far observations, which complies with the stylized fact regarding the evolution of macroeconomic dynamics. We illustrate our technique via a comprehensive simulation exercise and three real applications in growing dimensions.