Achieving Shrinkage in a Time-Varying Parameter Model Framework

Abstract: Shrinkage for time-varying parameter (TVP) models is investigated within a Bayesian framework, with the aim to automatically reduce time-varying parameters to static ones, if the model is overfitting. This is achieved through placing the double gamma shrinkage prior on the process variances. An efficient Markov chain Monte Carlo scheme is developed, exploiting boosting based on the ancillarity-sufficiency interweaving strategy. The method is applicable both to TVP models for univariate as well as multivariate time series. Applications include a TVP generalized Phillips curve for EU area inflation modelling and a multivariate TVP Cholesky stochastic volatility model for joint modelling of the returns from the DAX-30 index.