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Prior Selection for Vector Autoregressions

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  • Domenico Giannone
  • Michele Lenza
  • Giorgio E. Primiceri

Abstract

Vector autoregressions (VARs) are flexible time series models that can capture complex dynamic interrelationships among macroeconomic variables. However, their dense parameterization leads to unstable inference and inaccurate out-of-sample forecasts, particularly for models with many variables. A solution to this problem is to use informative priors, in order to shrink the richly parameterized unrestricted model towards a parsimonious naïve benchmark, and thus reduce estimation uncertainty. This paper studies the optimal choice of the informativeness of these priors, which we treat as additional parameters, in the spirit of hierarchical modeling. This approach is theoretically grounded, easy to implement, and greatly reduces the number and importance of subjective choices in the setting of the prior. Moreover, it performs very well both in terms of out-of-sample forecasting--as well as factor models--and accuracy in the estimation of impulse response functions.

Suggested Citation

  • Domenico Giannone & Michele Lenza & Giorgio E. Primiceri, 2012. "Prior Selection for Vector Autoregressions," NBER Working Papers 18467, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:18467
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    References listed on IDEAS

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    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications

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