We apply Bayesian methods to study a common vector autoregression (VAR)-based approach for decomposing the variance of excess stock returns into components reflecting news about future excess stock returns, future real interest rates, and future dividends. We develop a new prior elicitation strategy, which involves expressing beliefs about the components of the variance decomposition. Previous Bayesian work elicited priors from the difficult-to-interpret parameters of the VAR. With a commonly used data set, we find that the posterior standard deviations for the variance decomposition based on these previously used priors, including "non-informative" limiting cases, are much larger than classical standard errors based on asymptotic approximations. Therefore, the non-informative researcher remains relatively uninformed about the variance decomposition after observing the data. We show the large posterior standard deviations arise because the "non-informative" prior is implicitly very informative in a highly undesirable way. However, reasonably informative priors using our elicitation method allow for much more precise inference about components of the variance decomposition. © 2003 Elsevier B.V. All rights reserved.
CITATION STYLE
Hollifield, B., Koop, G., & Li, K. (2003). A Bayesian analysis of a variance decomposition for stock returns. Journal of Empirical Finance, 10(5), 583–601. https://doi.org/10.1016/S0927-5398(03)00006-9
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