STEADY-STATE PRIORS AND BAYESIAN VARIABLE SELECTION IN VAR FORECASTING
Dimitrios P. Louzis
Bank of Greece
Abstract
This study proposes methods for estimating Bayesian vector autoregressions (VARs) with an automatic variable selection and an informative prior on the unconditional mean or steady-state of the system. We show that extant Gibbs sampling methods for Bayesian variable selection can be efficiently extended to incorporate prior beliefs on the steady-state of the economy. Empirical analysis, based on three major US macroeconomic time series, indicates that the out-of-sample forecasting accuracy of a VAR model is considerably improved when it combines both variable selection and steady-state prior information.
Keywords: Bayesian VAR, Steady states, Variable selection, Macroeconomic forecasting
JEL Classifications: C32
Acknowledgement: The author would like to thank Heather Gibson for her constructive comments and suggestions. The views expressed in this article do not necessarily represent those of the Bank of Greece.
Correspondence:
Dimitrios P. Louzis
Bank of Greece,
Economic Analysis and Research Department
3 Amerikis Str., 10564
Athens, Greece.
Email: dlouzis@aueb.gr ; dlouzis@bankofgreece.gr