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Prior parameter uncertainty: Some implications for forecasting and policy analysis with VAR models

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John C. Robertson
Ellis W. Tallman

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Abstract

Models used for policy analysis should generate reliable unconditional forecasts as well as policy simulations (conditional forecasts) that are based on a structural model of the economy. Vector autoregression (VAR) models have been criticized for having inaccurate forecasts as well as being difficult to interpret in the context of an underlying economic model. In this paper, we examine how the treatment of prior uncertainty about parameter values can affect forecasting accuracy and the interpretation of identified structural VAR models. ; Typically, VAR models are specified with long lag orders and a diffuse prior about the unrestricted coefficients. We find evidence that alternatives that emphasize nonstationary aspects of the data as well as parsimony in parameterization have better out-of-sample forecast performance and smoother and more persistent responses to a given exogenous monetary policy change than do unrestricted VARs.

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Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 99-13.

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Date of creation: 1999
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Handle: RePEc:fip:fedawp:99-13

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Keywords: Forecasting ; Vector autoregression ; Econometric models;

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  3. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January. [Downloadable!] (restricted)
  4. Highfield, Richard A. & O'Hara, Maureen & Wood, John H., 1991. "Public ends, private means : Central banking and the profit motive 1823-1832," Journal of Monetary Economics, Elsevier, vol. 28(2), pages 287-322, October. [Downloadable!] (restricted)
  5. Kadiyala, K Rao & Karlsson, Sune, 1997. "Numerical Methods for Estimation and Inference in Bayesian VAR-Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 12(2), pages 99-132, March-Apr. [Downloadable!]
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  6. Thomas Doan & Robert B. Litterman & Christopher A. Sims, 1986. "Forecasting and conditional projection using realistic prior distribution," Staff Report 93, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  7. Faust, Jon, 1998. "The robustness of identified VAR conclusions about money," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 49(1), pages 207-244, December. [Downloadable!] (restricted)
  8. Rudebusch, Glenn D, 1998. "Do Measures of Monetary Policy in a VAR Make Sense?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 907-31, November.
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  9. Dreze, Jacques H. & Richard, Jean-Francois, 1983. "Bayesian analysis of simultaneous equation systems," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 1, chapter 9, pages 517-598 Elsevier. [Downloadable!] (restricted)
  10. John C. Robertson & Ellis W. Tallman, 1999. "Improving forecasts of the federal funds rate in a policy model," Working Paper 99-3, Federal Reserve Bank of Atlanta. [Downloadable!]
  11. Christopher A. Sims & Tao Zha, 1999. "Error Bands for Impulse Responses," Econometrica, Econometric Society, vol. 67(5), pages 1113-1156, September.
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  12. Christopher A. Sims, 1992. "A Nine Variable Probabilistic Macroeconomic Forecasting Model," Cowles Foundation Discussion Papers 1034, Cowles Foundation, Yale University. [Downloadable!]
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  13. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Adrian R. Pagan & John C. Robertson, 1995. "Resolving the liquidity effect," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 33-54. [Downloadable!]
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  15. Christopher A. Sims, 1998. "Role of interest rate policy in the generation and propagation of business cycles: what has changed since the '30s?," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, issue Jun, pages 121-175. [Downloadable!]
  16. Robert B. Litterman, 1979. "Techniques of forecasting using vector autoregressions," Working Papers 115, Federal Reserve Bank of Minneapolis. [Downloadable!]
  17. James E. Kennedy, 1989. "The effect of Bayesian priors on the moving-average representation of vector autoregressions," Finance and Economics Discussion Series 79, Board of Governors of the Federal Reserve System (U.S.).
  18. Daniel F. Waggoner & Tao Zha, 1998. "Conditional forecasts in dynamic multivariate models," Working Paper 98-22, Federal Reserve Bank of Atlanta. [Downloadable!]
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  19. Gordon, David B & Leeper, Eric M, 1994. "The Dynamic Impacts of Monetary Policy: An Exercise in Tentative Identification," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1228-47, December. [Downloadable!] (restricted)
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  20. John C. Robertson & Ellis W. Tallman, 1999. "Vector autoregressions: forecasting and reality," Economic Review, Federal Reserve Bank of Atlanta, issue Q1, pages 4-18. [Downloadable!]
  21. Sims, Christopher A & Zha, Tao, 1998. "Bayesian Methods for Dynamic Multivariate Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 949-68, November.
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  22. Jon Faust, 1998. "The robustness of identified VAR conclusions about money," International Finance Discussion Papers 610, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  23. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1996-2), pages 1-78. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Andrea Brischetto & Graham Voss, 1999. "A Structural Vector Autoregression Model of Monetary Policy in Australia," RBA Research Discussion Papers rdp1999-11, Reserve Bank of Australia. [Downloadable!]
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