Addressing COVID-19 Outliers in BVARs with Stochastic Volatility

51 Pages Posted: 3 Feb 2021 Last revised: 10 Aug 2021

See all articles by Todd E. Clark

Todd E. Clark

Federal Reserve Bank of Cleveland

Andrea Carriero

Queen Mary, University of London

Massimiliano Giuseppe Marcellino

Bocconi University - Department of Economics; Centre for Economic Policy Research (CEPR)

Elmar Mertens

Deutsche Bundesbank

Multiple version iconThere are 2 versions of this paper

Date Written: August 9, 2021

Abstract

The COVID-19 pandemic has led to enormous movements in economic data that strongly affect parameters and forecasts obtained from standard VARs. One way to address these issues is to model extreme observations as random shifts in the stochastic volatility (SV) of VAR residuals. Specifically, we propose VAR models with outlier-augmented SV that combine transitory and persistent changes in volatility. The resulting density forecasts for the COVID-19 period are much less sensitive to outliers in the data than standard VARs. Evaluating forecast performance over the last few decades, we find that outlier-augmented SV schemes do at least as well as a conventional SV model. Predictive Bayes factors indicate that our outlier-augmented SV model provides the best data fit for the period since the pandemic’s outbreak, as well as for earlier subsamples of relatively high volatility.

Keywords: Bayesian VARs, stochastic volatility, outliers, pandemics, forecasts

JEL Classification: C53, E17, E37, F47

Suggested Citation

Clark, Todd E. and Carriero, Andrea and Marcellino, Massimiliano and Mertens, Elmar, Addressing COVID-19 Outliers in BVARs with Stochastic Volatility (August 9, 2021). FRB of Cleveland Working Paper No. 21-02R, Available at SSRN: https://ssrn.com/abstract=3778262 or http://dx.doi.org/10.2139/ssrn.3778262

Todd E. Clark (Contact Author)

Federal Reserve Bank of Cleveland ( email )

P.O. Box 6387
Cleveland, OH 44101
United States
216-579-2015 (Phone)

Andrea Carriero

Queen Mary, University of London ( email )

Mile End Road
London, London E1 4NS
United Kingdom

Massimiliano Marcellino

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Elmar Mertens

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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