Time-varying parameters vs. rolling windowsSource:
In this tutorial, I compare the coefficients estimated using a
rolling window regression to those estimated using a Bayesian
time-varying parameter model. For a primer on how to fit rolling window
tidyfit, please see here.
This articles follows directly from the linked primer, but focuses on
only one industry.
data <- Factor_Industry_Returns data <- data %>% mutate(Date = ym(Date)) %>% # Parse dates mutate(Return = Return - RF) %>% # Excess return select(-RF) data #> # A tibble: 7,080 × 8 #> Date Industry Return `Mkt-RF` SMB HML RMW CMA #> <date> <chr> <dbl> <dbl> <dbl> <dbl> <dbl> <dbl> #> 1 1963-07-01 NoDur -0.76 -0.39 -0.44 -0.89 0.68 -1.23 #> 2 1963-08-01 NoDur 4.64 5.07 -0.75 1.68 0.36 -0.34 #> 3 1963-09-01 NoDur -1.96 -1.57 -0.55 0.08 -0.71 0.29 #> 4 1963-10-01 NoDur 2.36 2.53 -1.37 -0.14 2.8 -2.02 #> 5 1963-11-01 NoDur -1.4 -0.85 -0.89 1.81 -0.51 2.31 #> 6 1963-12-01 NoDur 2.52 1.83 -2.07 -0.08 0.03 -0.04 #> 7 1964-01-01 NoDur 0.49 2.24 0.11 1.47 0.17 1.51 #> 8 1964-02-01 NoDur 1.61 1.54 0.3 2.74 -0.05 0.9 #> 9 1964-03-01 NoDur 2.77 1.41 1.36 3.36 -2.21 3.19 #> 10 1964-04-01 NoDur -0.77 0.1 -1.59 -0.58 -1.27 -1.04 #> # ℹ 7,070 more rows
We will examine only the HiTec industry to avoid unnecessary complexity:
We begin by fitting a rolling window OLS regression with adjusted
standard errors. In this example, we cannot simply pass both the TVP and
the OLS models to the same
regress function because the
rolling window regression requires a
.force_cv = TRUE
argument, while the TVP model does not need to be fitted on rolling
slices. The below code is adapted directly from the previous article on
rolling window regressions:
The TVP model is fitted next.
tidyfit uses the
shrinkTVP package to fit TVP models. The package is
extremely powerful and provides a Bayesian implementation with a
specialized hierarchical prior that automatically shrinks some of the
parameters towards constant processes based on the data. While I do not
discuss this in more detail, have a look here for more information.
sv = TRUE adds stochastic volatility, while the
index_col argument is a convenience feature added by
tidyfit to allow the index column (i.e. the dates) to be
passed through to the estimates.
Next we combine the two model frames:
mod_frame <- bind_rows(mod_rolling, mod_tvp)
The coefficients for all models can be obtained in the usual manner:
beta <- coef(mod_frame)
Now, however, we require some wrangling to adapt the output of the
two methods. First we unnest the detailed model information. This
contains upper and lower credible intervals for the TVP model. For the
OLS model we generate the confidence interval, as before. Finally, we
index columns into a
Plotting the outcome is relatively simple with
beta %>% ggplot(aes(date, estimate)) + facet_wrap("term", scales = "free", ncol = 2) + geom_ribbon(aes(ymax = upper, ymin = lower, fill = model), alpha = 0.25) + geom_line(aes(color = model)) + theme_bw(8)
We can make a two interesting observations from these results:
- The variation seen in the rolling regression for some of the parameters — specifically the risk-adjusted alpha (intercept) and the market beta — is not supported by the TVP model, which shrinks these to almost constant parameters.
- The TVP estimates are markedly smoother and importantly remove the window effects seen in the rolling regression (i.e. the rolling regression adjusts too late).
The TVP model seems to offer a much better tool analyze the factor betas in this case.