COMBINING VAR ESTIMATION AND STATE-SPACE MODEL-REDUCTION FOR SIMPLE GOOD PREDICTIONS

A combination of VAR estimation and state space model reduction techni ques are examined by Monte Carlo methods in order to find good, simple to use, procedures for determining models which have reasonable predi ction properties. The presentation is largely graphical. This helps fo cus attention on the aspects of the model determination problem which are relatively important for forecasting. One surprising result is tha t, for prediction purposes, knowledge of the true structure of the mod el generating the data is not particularly useful unless parameter val ues are also known. This is because the difficulty in estimating param eters of the true model causes more prediction error than results from a more parsimonious approximate model.