A Lucas Critique Compliant SVAR Model With Observation-Driven Time-Varying Parameters

Abstract

We propose an observation-driven time-varying SVAR model where, in agreement with the Lucas Critique, structural shocks drive both the evolution of the macro variables and the dynamics of the VAR parameters. Contrary to existing approaches where parameters follow a stochastic process with random and exogenous shocks, our observation-driven specification allows the evolution of the parameters to be driven by realized past structural shocks, thus opening the possibility to gauge the impact of observed shocks and hypothetical policy interventions on the future evolution of the economic system.

Keywords: Time-varying VAR models, Independent Component Analysis, Score-driven models

JEL Classification: C14, C32, C51