Dear All,

I have estimated my DSGE model, I have generated both in-sample shock decomposition and out-of-sample forecast error variance decomposition, i find some shocks contribute a lot to out-of-sample forecast error variance decomposition but contribute very little to in-sample shock decomposition, i am wondering that is it normal or does it indicate model misspecification?

Thank you very much and look forward to hearing from you.

Kind regards,

Jesse

That is not completely unheard of, but quite unusual. Usually the two should quite coincide (at horizon infinity for the FEVD). This might indeed be a sign of misspecification

Dear Johannes,

Thank you very much! Does this mean my DSGE model will be useless for forecasting?

thank you and look forward to hearing from you.

Kind regards,

Jesse

I would tend to say that is the case. Of course, you can always argue that the in-sample realizations of the shocks were special and that the FEVD, which cares about theoretical/asymptotic properties is a more realistic guidance. But most people would probably reject this argument, saying that if it does not work in-sample, it will not work asymptotically.

Dear Johannes,

Thank you very much for your helpful guidance. in my model, there are 20 structural shocks and 20 observed variables, only 2 of them encounter such a problem,

in shock decomposition the shock X accounts for 5% of observed variable Y, but in forecast error variance decomposition, shock X accounts for 20% of observed variable Y’s variation.

Since the number of shocks are relatively large-20, and only 2 shocks encounter such problems, does this mean the misspecification problem is less severe?

Thank you very much and look forward to hearing from you.

Kind regards,

Jesse

That still sounds reasonable. The last factor to consider is how long your sample is. If it’s rather short, then you should be fine.

Dear Johannes,

Thank you very much.

I just have one last question. My in-sample size is 90 quarters, and my forecast horizon is 8 quarters. is 90 quarters a relatively short in sample or not?

Thank you again and look forward to hearing from you.

Kind regards,

Jesse

Yes, that is short. And forecast horizons smaller than infinity in the FEVD cannot easily be compared to the historical decomposition results. Horizon 8 is rather small. Or were you talking about the actual forecasts you are trying to make? In that case, forget my last comment.