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Forecasting and conditional projection using realistic prior distribution

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  • Thomas Doan
  • Robert B. Litterman
  • Christopher A. Sims

Abstract

This paper develops a forecasting procedure based on a Bayesian method for estimating vector autoregressions. We apply the procedure to 10 macroeconomic variables and show that it produces more accurate out-of-sample forecasts than univariate equations do. Although cross-variable responses are damped by the prior, our estimates capture considerable interaction among the variables. ; We provide unconditional forecasts as of 1982:12 and 1983:3. We also describe how a model such as this can be used to make conditional projections and analyze policy alternatives. As an example, we analyze a Congressional Budget Office forecast made in 1982:12. ; While no automatic casual interpretations arise from models like ours, such models provide a detailed characterization of the dynamic statistical interdependence of a set of economic variables. That information may help evaluate casual hypotheses without containing any such hypotheses.

Suggested Citation

  • 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.
  • Handle: RePEc:fip:fedmsr:93
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    References listed on IDEAS

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    1. John Geweke, 1979. "The Temporal and Sectoral Aggregation of Seasonally Adjusted Time Series," NBER Chapters,in: Seasonal Analysis of Economic Time Series, pages 411-432 National Bureau of Economic Research, Inc.
    2. Robert B. Litterman, 1979. "Techniques of forecasting using vector autoregressions," Working Papers 115, Federal Reserve Bank of Minneapolis.
    3. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
    4. Leamer, Edward E, 1972. "A Class of Informative Priors and Distributed Lag Analysis," Econometrica, Econometric Society, vol. 40(6), pages 1059-1081, November.
    5. Kloek, Tuen & van Dijk, Herman K, 1978. "Bayesian Estimates of Equation System Parameters: An Application of Integration by Monte Carlo," Econometrica, Econometric Society, vol. 46(1), pages 1-19, January.
    6. Sims, Christopher A, 1983. "Is There a Monetary Business Cycle?," American Economic Review, American Economic Association, vol. 73(2), pages 228-233, May.
    7. Litterman, Robert B, 1983. "A Random Walk, Markov Model for the Distribution of Time Series," Journal of Business & Economic Statistics, American Statistical Association, vol. 1(2), pages 169-173, April.
    8. Shiller, Robert J, 1973. "A Distributed Lag Estimator Derived from Smoothness Priors," Econometrica, Econometric Society, vol. 41(4), pages 775-788, July.
    9. Litterman, Robert B, 1983. "A Random Walk, Markov Model for the Distribution of Time Series," Journal of Business & Economic Statistics, American Statistical Association, vol. 1(2), pages 169-173, April.
    10. Christopher A. Sims, 1982. "Policy Analysis with Econometric Models," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 13(1), pages 107-164.
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