The Systematic Specification of a Full Prior Covariance Matrix for Asset Demand Equations

Gary Smith

The Quarterly Journal of Economics, 1981, vol. 96, issue 2, 317-339

Abstract: Linear expenditure systems are widely used to describe consumption and portfolio decisions. However, the complexity of these models makes estimation a formidable task. In earlier work, an exchangeability assumption was used to incorporate subjective a priori information into the estimation of asset demand equations. Here, an alternative hierarchical approach is described and illustrated. This procedure provides a framework in which the identification of a limited number of distinct reasons for prior uncertainty can be converted into a full prior covariance matrix. Such a matrix can then be combined with prior means and the sample data to yield Bayesian parameter estimates.

Date: 1981
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