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Vector Autoregressions and Macroeconomic Modeling: An Error Taxonomy


Poskitt, DS and Yao, W, Vector Autoregressions and Macroeconomic Modeling: An Error Taxonomy, Journal of Business and Economic Statistics, 35, (3) pp. 407-419. ISSN 0735-0015 (2017) [Refereed Article]

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DOI: doi:10.1080/07350015.2015.1077139


In this article we investigate the theoretical behaviour of finite lag VAR(n) models fitted to time series that in truth come from an infinite order VAR(∞) data generating mechanism. We show that the overall error can be broken down into two basic components, an estimation error that stems from the difference between the parameter estimates and their population ensemble VAR(n) counterparts, and an approximation error that stems from the difference between the VAR(n) and the true VAR(∞). The two sources of error are shown to be present in other performance indicators previously employed in the literature to characterize, so called, truncation effects. Our theoretical analysis indicates that the magnitude of the estimation error exceeds that of the approximation error, but experimental results based upon a prototypical real business cycle model and a practical example indicate that the approximation error approaches its asymptotic position far more slowly than does the estimation error, their relative orders of magnitude notwithstanding. The experimental results suggest that with sample sizes and lag lengths like those commonly employed in practice VAR(n) models are likely to exhibit serious errors of both types when attempting to replicate the dynamics of the true underlying process and that inferences based on VAR(n) models can be very untrustworthy.

Item Details

Item Type:Refereed Article
Keywords:approximation error; estimation error; bias; structural VAR; order of magnitude.
Research Division:Economics
Research Group:Econometrics
Research Field:Time-series analysis
Objective Division:Economic Framework
Objective Group:Macroeconomics
Objective Field:Macroeconomics not elsewhere classified
UTAS Author:Yao, W (Dr Wenying Yao)
ID Code:102439
Year Published:2017 (online first 2015)
Web of Science® Times Cited:1
Deposited By:TSBE
Deposited On:2015-08-20
Last Modified:2017-12-14

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