On the predictability of time-varying VAR and DSGE models

Over the last few years, there has been a growing interest in DSGE modelling for predicting macroeconomic ‡uctuations and conducting quantitative policy analysis. Hybrid DSGE models have become popular for dealing with some of the DSGE misspeci…cations as they are able to solve the tradeo¤ between theoretical coherence and empirical …t. However, these models are still linear and they do not consider time-variation for parameters. The time-varying properties in VAR or DSGE models capture the inherent nonlinearities and the adaptive underlying structure of the economy in a robust manner. In this paper, we present a state space time-varying parameter VAR model. Moreover, we focus on the DSGE-VAR that combines a micro-founded DSGE model with the ‡exibility of a VAR framework. All the aforementioned models as well simple DSGEs and Bayesian VARs are used in a comparative investigation of their out-of-sample predictive performance regarding the US economy. The results indicate that while in general the classical VAR and BVARs provide with good forecasting results, in many cases the TVP-VAR and the DSGE-VAR outperform the other models. Keywords Hybrid DSGE Time-varying VAR Kalman …lter Bayesian VAR Forecasting JEL Classi…cation C11 C15 C32 S. Bekiros European University Institute (EUI), Department of Economics, Via della Piazzuola 43 I50133, Florence, Italy Tel.: +39-055-4685-916 Fax: +39-055-4685-902 E-mail: [email protected] A. Paccagnini Università degli Studi di Milano-Bicocca, Department of Economics, Piazza Ateneo Nuovo 1, 20126 Milano, Italy and European University Institute (EUI), Max Weber Programme Via delle Fontanelle 10, I-50014 Florence, Italy E-mail: [email protected]