Adaptive shrinkage in Bayesian vector autoregressive models

Vector autoregressive (VAR) models are frequently used for forecasting and impulse response analysis. For both applications, shrinkage priors can help improving inference. In this paper we apply the shrinkage prior of Griffin and Brown (2010) to the VAR with stochastic volatility case and derive its relevant conditional posterior distributions. This framework imposes a set of normally distributed priors on the autoregressive coefficients and the covariance parameters of the VAR along with Gamma priors on a set of local and global prior scaling parameters. In a second step, we modify this prior setup by introducing another layer of shrinkage with scaling parameters that push certain regions of the parameter space to zero. Two simulation exercises show that the proposed framework yields more precise estimates of model parameters and impulse response functions. In addition, a forecasting exercise applied to US data shows that this prior performs well relative to other commonly used specifications in terms of point and density predictions. Finally, performing structural inference suggests that responses to monetary policy shocks appear to be reasonable.