Structural Vector Autoregressions with Smooth Transition in Variances: The Interaction Between U.S. Monetary Policy and the Stock Market

In structural vector autoregressive analysis identifying the shocks of interest via heteroskedasticity has become a standard tool. Unfortunately, the approaches currently used for modeling heteroskedasticity all have drawbacks.
For instance, assuming known dates for variance changes is often unrealistic while more exible models based on GARCH or Markov switching residuals are dicult to handle from a statistical and computational point of view. Therefore we propose a model based on a smooth change in variance that is exible as well as relatively easy to estimate. The model is applied to a ve-dimensional system of U.S. variables to explore the interaction between monetary policy and the stock market. It is found that previously used conventional identication schemes in this context are rejected by the data if heteroskedasticity is allowed for. Shocks identied via heteroskedasticity have a dierent economic interpretation than the shocks identied using conventional methods.

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