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Fat-tails in VAR Models

  • Ching-Wai (Jeremy) Chiu

    (Bank of England)

  • Haroon Mumtaz

    ()

    (Queen Mary University of London)

  • Gabor Pinter

    (Bank of England)

We confirm that standard time-series models for US output growth, inflation, interest rates and stock market returns feature non-Gaussian error structure. We build a 4-variable VAR model where the orthogonolised shocks have a Student t-distribution with a time-varying variance. We find that in terms of in-sample fit, the VAR model that features both stochastic volatility and Student-t disturbances outperforms restricted alternatives that feature either attributes. The VAR model with Student-t disturbances results in density forecasts for industrial production and stock returns that are superior to alternatives that assume Gaussianity. This difference appears to be especially stark over the recent financial crisis.

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File URL: http://econ.qmul.ac.uk/research/workingpapers/2014/Items/docs/714.pdf
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Paper provided by Queen Mary University of London, School of Economics and Finance in its series Working Papers with number 714.

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Date of creation: Mar 2014
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Handle: RePEc:qmw:qmwecw:wp714
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  1. Giorgio E. Primiceri, 2005. "Time Varying Structural Vector Autoregressions and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 821-852.
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  8. Timothy Cogley & Thomas J. Sargent, 2005. "Drift and Volatilities: Monetary Policies and Outcomes in the Post WWII U.S," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 262-302, April.
  9. Siddhartha Chib & Srikanth Ramamurthy, 2014. "DSGE Models with Student- t Errors," Econometric Reviews, Taylor & Francis Journals, vol. 33(1-4), pages 152-171, June.
  10. Zheng Liu & Daniel F. Waggoner & Tao Zha, 2010. "Sources of Macroeconomic Fluctuations: A Regime-switching DSGE Approach," Emory Economics 1002, Department of Economics, Emory University (Atlanta).
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  12. Jacquier, Eric & Polson, Nicholas G. & Rossi, P.E.Peter E., 2004. "Bayesian analysis of stochastic volatility models with fat-tails and correlated errors," Journal of Econometrics, Elsevier, vol. 122(1), pages 185-212, September.
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