Bayesian Analysis of Coefficient Instability in Dynamic Regressions

64 Pages Posted: 24 Feb 2012

Date Written: November 23, 2011

Abstract

This paper proposes a Bayesian regression model with time-varying coefficients (TVC) that makes it possible to estimate jointly the degree of instability and the time-path of regression coefficients. Thanks to its computational tractability, the model proves suitable to perform the first (to our knowledge) Monte Carlo study of the finite-sample properties of a TVC model. Under several specifications of the data generating process, the proposed model’s estimation precision and forecasting accuracy compare favourably with those of other methods commonly used to deal with parameter instability. Furthermore, the TVC model leads to small losses of efficiency under the null of stability and it is robust to mis-specification, providing a satisfactory performance also when regression coefficients experience discrete structural breaks. As a demonstrative application, we use our TVC model to estimate the exposures of S&P 500 stocks to market-wide risk factors: we find that a vast majority of stocks have time-varying risk exposures and that the TVC model helps to forecast these exposures more accurately.

Keywords: time-varying regression, coefficient instability

JEL Classification: C11, C32, C50

Suggested Citation

Ciapanna, Emanuela and Taboga, Marco, Bayesian Analysis of Coefficient Instability in Dynamic Regressions (November 23, 2011). Bank of Italy Temi di Discussione (Working Paper) No. 836, Available at SSRN: https://ssrn.com/abstract=2009900 or http://dx.doi.org/10.2139/ssrn.2009900

Emanuela Ciapanna (Contact Author)

Bank of Italy ( email )

Research Department
Via Nazionale 91
Roma, 00184
Italy
00390647922188 (Phone)

Marco Taboga

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

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