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Does Bayesian Shrinkage Help to Better Reflect What Happened during the Subprime Crisis?

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  • Olfa Kaabia
  • Ilyes Abid
  • Khaled Guesmi

Abstract

We study the contagion effects of a U.S. housing shock on OECD countries over the period of the subprime crisis. Considering a large database containing national macroeconomic, financial, and trade dynamic variables for 17 OECD countries, we evaluate forecasting accuracy, and perform a structural analysis exercise using VAR models of different sizes: a standard VAR estimated by OLS and a MEDIUM and LARGE VARs estimated by a Bayesian shrinkage procedure. Our main findings are that: First, the largest specification outperforms the smallest one in terms of forecast accuracy. Second, the MEDIUM VAR outperforms both the LARGE BVAR and the SMALL VAR in the case of structural analysis. So the MEDIUM VAR is sufficient to provide plausible impulse responses, and reproduce more realistically what happened during the subprime crisis. Third, the Bayesian shrinkage procedure is preferable to the standard OLS estimation in the case of an international contagion study.

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Paper provided by University of Paris West - Nanterre la Défense, EconomiX in its series EconomiX Working Papers with number 2012-46.

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Length: 28 pages
Date of creation: 2012
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Handle: RePEc:drm:wpaper:2012-46

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Keywords: Contagion; subprime crisis; OECD housing markets; VAR/ BVAR models and Bayesian shrinkage;

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