Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 190: Forecasting Performance of an Open Economy Dynamic Stochastic General Equilibrium Model

Malin Adolfson (), Jesper Lindé () and Mattias Villani ()
Additional contact information
Malin Adolfson: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Jesper Lindé: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Mattias Villani: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Abstract: This paper analyzes the forecasting performance of an open economy DSGE model, estimated with Bayesian methods, for the Euro area during 1994Q1-2002Q4. We compare the DSGE model and a few variants of this model to various reduced form forecasting models such as vector autoregressions (VAR) and vector error correction models (VECM), estimated both by maximum likelihood and two different Bayesian approaches, and traditional benchmark models, e.g. the random walk. The accuracy of point forecasts, interval forecasts and the predictive distribution as a whole are assessed in an out-of-sample rolling event evaluation using several univariate and multivariate measures. The results show that the open economy DSGE model compares well with more empirical models and thus that the tension between rigor and fit in older generations of DSGE models is no longer present. We also critically examine the role of Bayesian model probabilities and other frequently used low-dimensional summaries, e.g. the log determinant statistic, as measures of overall forecasting performance.

Keywords: Bayesian inference; Forecasting; Open economy DSGE model; Vector autoregressive models

JEL-codes: C11; C32; E37; E47

39 pages, First version: September 1, 2005. Revised: June 1, 2006.

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