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Vector autoregressions with dynamic factor coefficients and conditionally heteroskedastic errors

Author

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  • Gorgi, Paolo
  • Koopman, Siem Jan
  • Schaumburg, Julia
Abstract
We introduce a new and general methodology for analyzing vector autoregressive models with time-varying coefficient matrices and conditionally heteroskedastic disturbances. The proposed approach is transparent and simple to implement. It allows the derivation of well-defined impulse response functions that rely on the overall stability of the system. We present the finite sample properties of the model in a simulation study. In an empirical illustration we investigate the possibly time-varying relationships between U.S. industrial production, inflation, and bond spread. We empirically identify a time-varying linkage between economic and financial variables which are effectively described by a common dynamic factor. The impulse response analysis identifies substantial differences in the effects of financial shocks on output and inflation during crisis and non-crisis periods. The results also illustrate how the widely-used approach of fixing the VAR coefficients in the derivation of the impulse responses leads to a sizeable underestimation of the impact of a financial shock on output and inflation during some of the crises in our sample.

Suggested Citation

  • Gorgi, Paolo & Koopman, Siem Jan & Schaumburg, Julia, 2024. "Vector autoregressions with dynamic factor coefficients and conditionally heteroskedastic errors," Journal of Econometrics, Elsevier, vol. 244(2).
    • Handle: RePEc:eee:econom:v:244:y:2024:i:2:s0304407624000964
    DOI: 10.1016/j.jeconom.2024.105750
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    References listed on IDEAS

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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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