Prior Selection for Vector Autoregressions

41 Pages Posted: 22 Nov 2012

See all articles by Domenico Giannone

Domenico Giannone

Centre for Economic Policy Research (CEPR); Amazon.com

Michele Lenza

European Central Bank (ECB)

Giorgio E. Primiceri

Northwestern University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: November 15, 2012

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.

Keywords: forecasting, Bayesian methods, marginal likelihood, hierarchical modeling, impulse responses

JEL Classification: C11, C32, C53, E37

Suggested Citation

Giannone, Domenico and Lenza, Michele and Primiceri, Giorgio E., Prior Selection for Vector Autoregressions (November 15, 2012). ECB Working Paper No. 1494, Available at SSRN: https://ssrn.com/abstract=2176133 or http://dx.doi.org/10.2139/ssrn.2176133

Domenico Giannone (Contact Author)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Amazon.com ( email )

Seattle, WA 98144
United States

Michele Lenza

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Giorgio E. Primiceri

Northwestern University - Department of Economics ( email )

2003 Sheridan Road
Evanston, IL 60208
United States

HOME PAGE: http://faculty.econ.northwestern.edu/faculty/primiceri

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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