DP12256 Economic Predictions with Big Data: The Illusion Of Sparsity

Author(s): Domenico Giannone, Michele Lenza, Giorgio E Primiceri
Publication Date: August 2017
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Programme Areas: Monetary Economics and Fluctuations
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12256

We compare sparse and dense representations of predictive models in macroeconomics, microeconomics and finance. To deal with a large number of possible predictors, we specify a "spike-and-slab" prior that allows for both variable selection and shrinkage. The posterior distribution does not typically concentrate on a single sparse or dense model but on a wide set of models. A clearer pattern of sparsity can only emerge when models of very low dimension are strongly favored a priori.