Common Drifting Volatility in Large Bayesian VARs∗

The general pattern of estimated volatilities of macroeconomic and financial variables is often broadly similar. We propose two models in which conditional volatilities feature comovement and study them using U.S. macroeconomic data. The first model specifies the conditional volatilities as driven by a single common unobserved factor, plus an idiosyncratic component. We label this model BVAR with General Factor Stochastic Volatility (BVAR-GFSV) and we show that the loss in terms of marginal likelihood from assuming a common factor for volatility is moderate. The second model, which we label BVAR with Common Stochastic Volatility (BVAR-CSV), is a special case of the BVARGFSV in which the idiosyncratic component is eliminated and the loadings to the factor are set to 1 for all the conditional volatilities. Such restrictions permit a convenient Kronecker structure for the posterior variance of the VAR coefficients, which in turn permits estimating the model even with large datasets. While perhaps misspecified, the BVAR-CSV model is strongly supported by the data when compared against standard homoskedastic BVARs, and it can produce relatively good point and density forecasts by taking advantage of the information contained in large datasets.