VARs, Common Factors and the Empirical Validation of Equilibrium Business Cycle Models

28 Pages Posted: 5 Feb 2003  

Domenico Giannone

Federal Reserve Banks - Federal Reserve Bank of New York; Centre for Economic Policy Research (CEPR); LUISS Guido Carli University

Lucrezia Reichlin

London Business School; Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES); Centre for Economic Policy Research (CEPR); European Central Bank (ECB)

Luca Sala

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER)

Multiple version iconThere are 2 versions of this paper

Date Written: January 2003

Abstract

Equilibrium business cycle models have typically less shocks than variables. As pointed out by Altug, 1989, and Sargent, 1989, if variables are measured with error, this characteristic implies that the model solution for measured variables has a factor structure. This Paper compares estimation performance for the impulse response coefficients based on a VAR approximation to this class of models and an estimation method that explicitly takes into account the restrictions implied by the factor structure. Bias and mean squared error for both factor based and VAR based estimates of impulse response functions are quantified using, as a data generating process, a calibrated standard equilibrium business cycle model. We show that, at short horizons, VAR estimates of impulse response functions are less accurate than factor estimates while the two methods perform similarly at medium and long run horizons.

Keywords: Dynamic factor models, structural VARs, identification, equilibrium business cycle models

JEL Classification: C33, C52, E32

Suggested Citation

Giannone, Domenico and Reichlin, Lucrezia and Sala, Luca, VARs, Common Factors and the Empirical Validation of Equilibrium Business Cycle Models (January 2003). CEPR Discussion Paper No. 3701. Available at SSRN: https://ssrn.com/abstract=377301

Domenico Giannone (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

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Centre for Economic Policy Research (CEPR)

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LUISS Guido Carli University ( email )

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Lucrezia Reichlin

London Business School ( email )

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Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES) ( email )

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Centre for Economic Policy Research (CEPR)

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European Central Bank (ECB) ( email )

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Luca Sala

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER) ( email )

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Italy
+39 02 5836 3326 (Phone)

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