Sparse Change-Point VAR models

62 Pages Posted: 10 Oct 2019

See all articles by Arnaud Dufays

Arnaud Dufays

CeReFiM. Université de Namur.; Université Laval

Li Zhuo

University of Melbourne - Faculty of Business and Economics

Jeroen Rombouts

ESSEC Business School

Yong Song

University of Melbourne

Date Written: August 28, 2019

Abstract

Change-point (CP) VAR models face a dimensionality curse due to the proliferation of parameters that arises when new breaks are detected. To handle large data sets, we introduce the Sparse CP-VAR model that determines which parameters truly vary when a break is detected. By doing so, the number of new parameters to estimate at each regime is drastically reduced and the CP dynamic becomes easier to interpret. The Sparse CP-VAR model disentangles the dynamics of the mean parameters and the covariance matrix. The former uses CP dynamics with shrinkage prior distributions while the latter is driven by an infinite hidden Markov framework. A simulation study highlights that the framework detects correctly the number of breaks per model parameter, and that it takes advantage of common breaks in the cross-sectional dimension to more precisely estimate them. Our applications on financial and macroeconomic systems highlight that the Sparse CP-VAR model helps interpreting the detected breaks. It turns out that many spillover effects have zero regimes meaning that they are zero for the entire sample period. Forecasting wise, the Sparse CP-VAR model is competitive against several recent time-varying parameter and CP-VAR models in terms of log predictive densities.

Keywords: Shrinkage prior, Structural breaks, Change-point model, Time-varying parameters, Forecasting, Relevant parameter change

JEL Classification: C11, C15, C22, C58

Suggested Citation

Dufays, Arnaud and Zhuo, Li and Rombouts, Jeroen and Song, Yong, Sparse Change-Point VAR models (August 28, 2019). Available at SSRN: https://ssrn.com/abstract=3461692 or http://dx.doi.org/10.2139/ssrn.3461692

Arnaud Dufays (Contact Author)

CeReFiM. Université de Namur. ( email )

Rempart de la Vierge 8
Namur, Namur 5000
Belgium

Université Laval ( email )

2214 Pavillon J-A. DeSeve
Quebec, Quebec G1K 7P4
Canada

Li Zhuo

University of Melbourne - Faculty of Business and Economics ( email )

Victoria, 3010
Australia

Jeroen Rombouts

ESSEC Business School ( email )

3 Avenue Bernard Hirsch
CS 50105 CERGY
CERGY, CERGY PONTOISE CEDEX 95021
France

Yong Song

University of Melbourne ( email )

185 Pelham Street
Carlton, Victoria 3053
Australia

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