Stochastic model specification in Markov switching vector error correction models

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Hauzenberger, Niko and Huber, Florian and Pfarrhofer, Michael and Zörner, Thomas O. (2021) Stochastic model specification in Markov switching vector error correction models. Studies in Nonlinear Dynamics and Econometrics, 25 (2). 20180069. ISSN 1558-3708 (https://doi.org/10.1515/snde-2018-0069)

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Abstract

This paper proposes a hierarchical modeling approach to perform stochastic model specification in Markov switching vector error correction models. We assume that a common distribution gives rise to the regime-specific regression coefficients. The mean as well as the variances of this distribution are treated as fully stochastic and suitable shrinkage priors are used. These shrinkage priors enable to assess which coefficients differ across regimes in a flexible manner. In the case of similar coefficients, our model pushes the respective regions of the parameter space towards the common distribution. This allows for selecting a parsimonious model while still maintaining sufficient flexibility to control for sudden shifts in the parameters, if necessary. We apply our modeling approach to real-time Euro area data and assume transition probabilities between expansionary and recessionary regimes to be driven by the cointegration errors. The results suggest that the regime allocation is governed by a subset of short-run adjustment coefficients and regime-specific variance-covariance matrices. These findings are complemented by an out-of-sample forecast exercise, illustrating the advantages of the model for predicting Euro area inflation in real time.

ORCID iDs

Hauzenberger, Niko ORCID logoORCID: https://orcid.org/0000-0002-2683-8421, Huber, Florian, Pfarrhofer, Michael and Zörner, Thomas O.;
  • Item type:Article
    ID code:87630
    Dates:
    Date
    Event
    24 February 2021
    Published
    1 December 2020
    Accepted
    Notes:Hauzenberger, Niko, Huber, Florian, Pfarrhofer, Michael and Zörner, Thomas O.. "Stochastic model specification in Markov switching vector error correction models" Studies in Nonlinear Dynamics & Econometrics, vol. 25, no. 2, 2021, pp. 20180069. https://doi.org/10.1515/snde-2018-0069#
    Subjects:Social Sciences > Economic Theory
    Department:Strathclyde Business School > Economics
    Depositing user: Pure Administrator
    Date deposited:14 Dec 2023 11:00
    Last modified:24 Dec 2024 01:24
    URI:https://strathprints.strath.ac.uk/id/eprint/87630
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