Adaptive State Space Models with Applications to the Business Cycle and Financial Stress

56 Pages Posted: 7 Nov 2016

See all articles by Davide Delle Monache

Davide Delle Monache

Bank of Italy

Ivan Petrella

University of Warwick; Centre for Economic Policy Research (CEPR)

Fabrizio Venditti

Bank of Italy

Date Written: November 2016

Abstract

In this paper we develop a new theoretical framework for the analysis of state space models with time-varying parameters. We let the driver of the time variation be the score of the predictive likelihood and derive a new filter that allows us to estimate simultaneously the state vector and the time-varying parameters. In this setup the model remains Gaussian, the likelihood function can be evaluated using the Kalman filter and the model parameters can be estimated via maximum likelihood, without requiring the use of computationally intensive methods. Using a Monte Carlo exercise we show that the proposed method works well for a number of different data generating processes. We also present two empirical applications. In the former we improve the measurement of GDP growth by combining alternative noisy measures, in the latter we construct an index of financial stress and evaluate its usefulness in nowcasting GDP growth in real time. Given that a variety of time series models have a state space representation, the proposed methodology is of wide interest in econometrics and statistics.

Keywords: Business cycle, financial stress., score-driven models, State space models, time-varying parameters

JEL Classification: C22, C32, C51, C53, E31

Suggested Citation

Delle Monache, Davide and Petrella, Ivan and Venditti, Fabrizio, Adaptive State Space Models with Applications to the Business Cycle and Financial Stress (November 2016). CEPR Discussion Paper No. DP11599. Available at SSRN: https://ssrn.com/abstract=2865867

Davide Delle Monache (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Ivan Petrella

University of Warwick ( email )

Gibbet Hill Rd.
Coventry, West Midlands CV4 8UW
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Fabrizio Venditti

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

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