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Classical time-varying FAVAR models - estimation, forecasting and structural analysis

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  • Eickmeier, Sandra
  • Lemke, Wolfgang
  • Marcellino, Massimiliano

Abstract

We propose a classical approach to estimate factor-augmented vector autoregressive (FAVAR) models with time variation in the factor loadings, in the factor dynamics, and in the variance-covariance matrix of innovations. When the time-varying FAVAR is estimated using a large quarterly dataset of US variables from 1972 to 2007, the results indicate some changes in the factor dynamics, and more marked variation in the factors' shock volatility and their loading parameters. Forecasts from the time-varying FAVAR are more accurate than those from a constant parameter FAVAR for most variables and horizons when computed insample, for some variables in pseudo real time, mostly financial indicators. Finally, we use the time-varying FAVAR to assess how monetary transmission to the economy has changed. We find substantial time variation in the volatility of monetary policy shocks, and we observe that the reaction of GDP, the GDP deflator, inflation expectations and long-term interest rates to an equally-sized monetary policy shock has decreased since the early-1980s.

Suggested Citation

  • Eickmeier, Sandra & Lemke, Wolfgang & Marcellino, Massimiliano, 2011. "Classical time-varying FAVAR models - estimation, forecasting and structural analysis," Discussion Paper Series 1: Economic Studies 2011,04, Deutsche Bundesbank.
  • Handle: RePEc:zbw:bubdp1:201104
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    Cited by:

    1. Bates, Brandon J. & Plagborg-Møller, Mikkel & Stock, James H. & Watson, Mark W., 2013. "Consistent factor estimation in dynamic factor models with structural instability," Journal of Econometrics, Elsevier, vol. 177(2), pages 289-304.
    2. Eickmeier, Sandra & Ng, Tim, 2011. "Forecasting national activity using lots of international predictors: An application to New Zealand," International Journal of Forecasting, Elsevier, vol. 27(2), pages 496-511, April.
    3. Han, Xu & Inoue, Atsushi, 2015. "Tests For Parameter Instability In Dynamic Factor Models," Econometric Theory, Cambridge University Press, vol. 31(05), pages 1117-1152, October.
    4. Eickmeier, Sandra & Ng, Tim, 2011. "How do credit supply shocks propagate internationally? A GVAR approach," Discussion Paper Series 1: Economic Studies 2011,27, Deutsche Bundesbank.
    5. Mawuli Segnon & Rangan Gupta & Stelios Bekiros & Mark E. Wohar, 2016. "Forecasting US GNP Growth: The Role of Uncertainty," Working Papers 201667, University of Pretoria, Department of Economics.
    6. Esteban Prieto & Sandra Eickmeier & Massimiliano Marcellino, 2016. "Time Variation in Macro‐Financial Linkages," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 31(7), pages 1215-1233, November.
    7. Han, Xu, 2015. "Tests for overidentifying restrictions in Factor-Augmented VAR models," Journal of Econometrics, Elsevier, vol. 184(2), pages 394-419.
    8. Breitung, Jörg & Eickmeier, Sandra, 2011. "Testing for structural breaks in dynamic factor models," Journal of Econometrics, Elsevier, vol. 163(1), pages 71-84, July.
    9. Koop, Gary & Korobilis, Dimitris, 2014. "A new index of financial conditions," European Economic Review, Elsevier, vol. 71(C), pages 101-116.
    10. Angela Abbate & Sandra Eickmeier & Wolfgang Lemke & Massimiliano Marcellino, 2016. "The Changing International Transmission of Financial Shocks: Evidence from a Classical Time‐Varying FAVAR," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(4), pages 573-601, June.
    11. Barnett, Alina & Mumtaz, Haroon & Theodoridis, Konstantinos, 2014. "Forecasting UK GDP growth and inflation under structural change. A comparison of models with time-varying parameters," International Journal of Forecasting, Elsevier, vol. 30(1), pages 129-143.

    More about this item

    Keywords

    FAVAR; time-varying parameters; monetary transmission; forecasting;

    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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