Forecasting and Conditional Projection Using Realistic Prior Distributions

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This paper develops a forecasting procedure based on a Bayesian method for estimating vector autoregressions. The procedure is applied to ten macroeconomic variables and is shown to improve out-of-sample forecasts relative to univariate equations. Although cross-variables responses are damped by the prior, considerable interaction among the variables is shown to be captured by the estimates.We provide unconditional forecasts as of 1982:12 and 1983:3.We also describe how a model such as this can be used to make conditional projections and to analyze policy alternatives. As an example, we analyze a Congressional Budget Office forecast made in 1982:12.While no automatic causal interpretations arise from models like ours, they provide a detailed characterization of the dynamic statistical interdependence of a set of economic variables, which may help inevaluating causal hypotheses, without containing any such hypotheses themselves.

Published: Doan, Thomas, Robert B. Litterman and Christopher A. Sims. "Forecasting and Conditional Projection Using Realistic Prior Distributions," Econometric Reviews, Vol. 3, No. 1 Jan. 1984, pp. 1-100.

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