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Inducing sparsity and shrinkage in time-varying parameter models

Author

Listed:
  • Huber, Florian
  • Koop, Gary
  • Onorante, Luca

Abstract

Time-varying parameter (TVP) models have the potential to be over-parameterized, particularly when the number of variables in the model is large. Global-local priors are increasingly used to induce shrinkage in such models. But the estimates produced by these priors can still have appreciable uncertainty. Sparsification has the potential to remove this uncertainty and improve forecasts. In this paper, we develop computationally simple methods which both shrink and sparsify TVP models. In a simulated data exercise we show the benefits of our shrink-then-sparsify approach in a variety of sparse and dense TVP regressions. In a macroeconomic forecast exercise, we find our approach to substantially improve forecast performance relative to shrinkage alone. JEL Classification: C11, C30, E3, D31

Suggested Citation

  • Huber, Florian & Koop, Gary & Onorante, Luca, 2019. "Inducing sparsity and shrinkage in time-varying parameter models," Working Paper Series 2325, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20192325
    Note: 412615
    as

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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecb.wp2325~e63f8eb1b0.en.pdf
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    References listed on IDEAS

    as
    1. Anirban Bhattacharya & Debdeep Pati & Natesh S. Pillai & David B. Dunson, 2015. "Dirichlet--Laplace Priors for Optimal Shrinkage," Journal of the American Statistical Association, Taylor & Francis Journals, vol. 110(512), pages 1479-1490, December.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    hierarchical priors; shrinkage; sparsity; time varying parameter regression;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)

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