Theoretical Questions Related to Bayesian Estimation


The purpose of this thread is to (hopefully) compile in one place all theory related questions with respect to Bayesian Estimation. Dynare does a lot of the work in the background, which is both convenient and dangerous. Hence, if you have a theory related question with respect to your work please post it here.

Here are a couple of general references to start with:

Chapter 9 of the Handbook of Macroeconomics: Solution and Estimation Methods for DSGE Models by Fernandez-Villaverde, Rubio-Ramirez and Schorfheide

“The Econometrics of DSGE Models” by Fernandez-Villaverde


I have a specific question related to the choice of observable variables to use and how to pick the additional shocks in order to identify them. For instance, I have a New Keynesian model with financial frictions and have the same 7 standard observables (and shocks) as in Smets and Wouter (2007). I also have data on 2 financial variables and would also like to include data on bond holdings. (Bonds are not neutral in my model) .However, I am not sure if that would make sense within the scope of the estimation. Also, how do we generally choose shocks in a model?



Generally, there is no good guidance. It is mostly trial and error. See also the section on selecting observables in Pfeifer(2013): “A Guide to Specifying Observation Equations for the Estimation of DSGE Models”


Thanks Johannes. I wasn’t aware you had written such an extensive guide yourself. Another paper I found with respect to choosing variables is Canova et al. (2014)


On a separate note, suppose one wants to introduce a new observable into a model. How does one also introduce the additional shock into the system? Should the shock be related somehow to the observable (or what might be affecting it)?


Usually, theory will guide you. It is a matter of debate whether full information estimation is sensible if you need to add a new structural shock for each variable you want to consider. One obvious way out is to assume measurement error.