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

  • John C. Robertson
  • Ellis W. Tallman

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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  8. Daniel F. Waggoner & Tao Zha, 1999. "Conditional Forecasts In Dynamic Multivariate Models," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 639-651, November.
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  17. 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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  19. Robert B. Litterman, 1979. "Techniques of forecasting using vector autoregressions," Working Papers 115, Federal Reserve Bank of Minneapolis.
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  23. 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.
  24. Canova, Fabio, 1991. "The Sources of Financial Crisis: Pre- and Post-Fed Evidence," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(3), pages 689-713, August.
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