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July/August 2007, 
Vol. 89, No. 4
Posted 2007-07-01

Model Fit and Model Selection

by Narayana Kocherlakota

This article uses an example to show that a model that fits the available data perfectly may provide worse answers to policy questions than an alternative, imperfectly fitting model. The author argues that, in the context of Bayesian estimation, this result can be interpreted as being due to the use of an inappropriate prior over the parameters of shock processes. He urges the use of priors that are obtained from explicit auxiliary information, not from the desire to obtain identification.