Scandinavian Working Papers in Economics

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

No 216: Bayesian forecast combination for VAR models

Michael K Andersson () and Sune Karlsson ()
Additional contact information
Michael K Andersson: Monetary Policy Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Sune Karlsson: Department of Business, Economics, Statistics and Informatics, Postal: Örebro University, SE-70182 Örebro

Abstract: We consider forecast combination and, indirectly, model selection for VAR models when there is uncertainty about which variables to include in the model in addition to the forecast variables. The key difference from traditional Bayesian variable selection is that we also allow for uncertainty regarding which endogenous variables to include in the model. That is, all models include the forecast variables, but may otherwise have differing sets of endogenous variables. This is a difficult problem to tackle with a traditional Bayesian approach. Our solution is to focus on the forecasting performance for the variables of interest and we construct model weights from the predictive likelihood of the forecast variables. The procedure is evaluated in a small simulation study and found to perform competitively in applications to real world data.

Keywords: Bayesian model averaging; Predictive likelihood; GDP forecasts

JEL-codes: C11; C15; C32; C52; C53

58 pages, November 1, 2007

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