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Bayesian Model Selection and Forecasting in Noncausal Autoregressive Models

Lanne, Markku and Luoma, Arto and Luoto, Jani (2009): Bayesian Model Selection and Forecasting in Noncausal Autoregressive Models.

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Abstract

In this paper, we propose a Bayesian estimation and prediction procedure for noncausal autoregressive (AR) models. Specifically, we derive the joint posterior density of the past and future errors and the parameters, which gives posterior predictive densities as a byproduct. We show that the posterior model probability provides a convenient model selection criterion and yields information on the probabilities of the alternative causal and noncausal specifications. This is particularly useful in assessing economic theories that imply either causal or purely noncausal dynamics. As an empirical application, we consider U.S. inflation dynamics. A purely noncausal AR model gets the strongest support, but there is also substantial evidence in favor of other noncausal AR models allowing for dependence on past inflation. Thus, although U.S. inflation dynamics seem to be dominated by expectations, the backward-looking component is not completely missing. Finally, the noncausal specifications seem to yield inflation forecasts which are superior to those from alternative models especially at longer forecast horizons.

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