State Correlation and Forecasting: A Bayesian Approach Using Unobserved Components Models
ANU Working Papers in Economics and Econometrics from Australian National University, College of Business and Economics, School of Economics
Implications to signal extraction that arise from specifying unobserved components (UC) models with correlated or orthogonal innovations have been well-investigated. In contrast, an analogous statement for forecasting evaluation cannot be made. This paper attempts to fill this gap in light of the recent resurgence of studies adopting UC models for forecasting purposes. In particular, four correlation structures are entertained: orthogonal, correlated, perfectly correlated innovations as well as a novel approach which combines features from two contrasting cases, namely, orthogonal and perfectly correlated innovations. Parameter space restrictions associated with different correlation structures and their connection with forecasting are discussed within a Bayesian framework. Introducing perfectly correlated innovations, however, reduces the covariance matrix rank. To accommodate that, a Markov Chain Monte Carlo sampler which builds upon properties of Toeplitz matrices and recent advances in precision-based algorithms is developed. Our results for several measures of U.S. inflation indicate that the correlation structure between state variables has important implications for forecasting performance as well as estimates of trend inflation.
Keywords: Bayesian; Markov Chain Monte Carlo; State Space; Unobserved ComponentsModels; ARIMA; Reduced Rank; Precision; Forecasting (search for similar items in EconPapers)
JEL-codes: C11 C15 C51 C53 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ecm, nep-ets, nep-for and nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations Track citations by RSS feed
Downloads: (external link)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: http://EconPapers.repec.org/RePEc:acb:cbeeco:2016-632
Access Statistics for this paper
More papers in ANU Working Papers in Economics and Econometrics from Australian National University, College of Business and Economics, School of Economics Contact information at EDIRC.
Series data maintained by ().