Smets and Wouters model estimated with skewed shocks - empirical study of forecasting properties

Abstract

In this paper we estimate a Smets and Wouters (2007) model with shocks following a closed skew normal distribution (csn) introduced in Gonzalez-Farias et al. (2004), which nests a normal distribution as a special case. In the paper we discuss priors for model parameters, including skewness-related parameters of shocks, i.e. location, scale and skewness parameters. Using data ranging from 1991Q1 to 2012Q2 we estimate the model and recursively verify its out-of sample forecasting properties for time period 2007Q1 - 2012Q2, therefore including the recent financial crisis, within a forecasting horizon from 1 up to 8 quarters ahead. Using a RMSE measure we compare the forecasting performance of the model with skewed shocks with a model estimated using normally distributed shocks. We find that inclusion of skewness can help forecasting some variables (consumption, investment and hours worked), but, on the other hand, results in deterioration in the other ones (output, infl ation wages and the short rate).