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Point and Density Forecasts for the Euro Area Using Many Predictors: Are Large BVARs Really Superior?

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  • Berg, Tim Oliver
  • Henzel, Steffen

Abstract

Forecast models with large cross-sections are often subject to overparameterization leading to unstable parameter estimates and hence inaccurate forecasts. Recent articles suggest that a large Bayesian vector autoregression (BVAR) with sufficient prior information dominates competing approaches. In this paper we evaluate the forecast performance of large BVAR in comparison to its most natural competitors, i.e. averaging of small-scale BVARs and factor augmented BVARs with and without shrinkage. We derive point and density forecasts for euro area real GDP growth and HICP inflation conditional on an information set which is appropriate for all approaches and find no consistent outperformance of the large BVAR. While it produces good point forecasts, the performance is poor when density forecasts are used to evaluate predictive ability. Moreover, the ranking of the different approaches depends inter alia on the target variable, the forecast horizon, the state of the business cycle, and on the size of the dataset. Overall, we find that a factor augmented BVAR with shrinkage is competitive in all setups. --

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Paper provided by Verein für Socialpolitik / German Economic Association in its series Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order with number 79783.

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Date of creation: 2013
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Handle: RePEc:zbw:vfsc13:79783

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  1. Boero, Gianna & Smith, Jeremy & Wallis, Kenneth F., 2011. "Scoring rules and survey density forecasts," International Journal of Forecasting, Elsevier, vol. 27(2), pages 379-393, April.
  2. Forni, Mario & Hallin, Marc & Lippi, Marco & Reichlin, Lucrezia, 2002. "Do Financial Variables Help Forecasting Inflation and Real Activity in the Euro Area?," CEPR Discussion Papers 3146, C.E.P.R. Discussion Papers.
  3. Karim Barhoumi & Olivier Darné & Laurent Ferrara, 2013. "Testing the Number of Factors: An Empirical Assessment for a Forecasting Purpose," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 75(1), pages 64-79, 02.
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