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

IGIER Working Paper No. 258

24 Pages Posted: 5 May 2004

See all articles by Luca Sala

Luca Sala

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

Domenico Giannone

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

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)

Multiple version iconThere are 2 versions of this paper

Date Written: April 2004

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 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: E32, C33, C52

Suggested Citation

Sala, Luca and Giannone, Domenico and Reichlin, Lucrezia, Vars, Common Factors and the Empirical Validation of Equilibrium Business Cycle Models (April 2004). IGIER Working Paper No. 258. Available at SSRN: https://ssrn.com/abstract=540043 or http://dx.doi.org/10.2139/ssrn.540043

Luca Sala (Contact Author)

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

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Domenico Giannone

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

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Centre for Economic Policy Research (CEPR)

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Lucrezia Reichlin

London Business School ( email )

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United Kingdom

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)

London
United Kingdom

European Central Bank (ECB) ( email )

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Frankfurt am Main, 60314
Germany

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