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The efficient market hypothesis and identification in structural VARs

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  • Lucio Sarno
  • Daniel L. Thornton

Abstract

Structural vector autoregression (SVAR) models are commonly used to investigate the effect of structural shocks on economic variables. The identifying restrictions imposed in many of these exercises have been criticized in the literature. This paper extends this literature by showing that, if the SVAR includes one or more variables that are efficient in the strong form of the efficient market hypothesis, the identifying restrictions frequently imposed in SVARs cannot be satisfied. The authors argue that this analysis will likely apply to VARs that include variables that are consistent with weaker forms of the efficient market hypothesis, especially when the data are measured at the monthly or quarterly frequencies, as is frequently the case.

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Bibliographic Info

Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2004)
Issue (Month): Jan ()
Pages: 49-60

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Handle: RePEc:fip:fedlrv:y:2004:i:jan:p:49-60:n:v.86no.1

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Keywords: Macroeconomics ; Econometric models;

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References

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  1. Thornton, Daniel L., 2001. "The Federal Reserve's operating procedure, nonborrowed reserves, borrowed reserves and the liquidity effect," Journal of Banking & Finance, Elsevier, Elsevier, vol. 25(9), pages 1717-1739, September.
  2. Lucio Sarno & Daniel L. Thornton, 2002. "The dynamic relationship between the federal funds rate and the Treasury bill rate: an empirical investigation," Working Papers, Federal Reserve Bank of St. Louis 2000-032, Federal Reserve Bank of St. Louis.
  3. Blanchard, Olivier Jean & Quah, Danny, 1989. "The Dynamic Effects of Aggregate Demand and Supply Disturbances," American Economic Review, American Economic Association, American Economic Association, vol. 79(4), pages 655-73, September.
  4. Ben S. Bernanke, 1986. "Alternative Explanations of the Money-Income Correlation," NBER Working Papers 1842, National Bureau of Economic Research, Inc.
  5. Arturo Estrella & Jeffrey C. Fuhrer, 2002. "Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational-Expectations Models," American Economic Review, American Economic Association, American Economic Association, vol. 92(4), pages 1013-1028, September.
  6. Olivier J. Blanchard & Mark W. Watson, 1986. "Are Business Cycles All Alike?," NBER Chapters, in: The American Business Cycle: Continuity and Change, pages 123-180 National Bureau of Economic Research, Inc.
  7. Wallis, Kenneth F, 1980. "Econometric Implications of the Rational Expectations Hypothesis," Econometrica, Econometric Society, Econometric Society, vol. 48(1), pages 49-73, January.
  8. V. Vance Roley & Carl E. Walsh, 1983. "Monetary Policy Regimes, Expected Inflation, and the Response of Interest Rates to Money Announcements," NBER Working Papers 1181, National Bureau of Economic Research, Inc.
  9. Matthew Shapiro & Mark Watson, 1988. "Sources of Business Cycles Fluctuations," NBER Chapters, in: NBER Macroeconomics Annual 1988, Volume 3, pages 111-156 National Bureau of Economic Research, Inc.
  10. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The effects of monetary policy shocks: evidence from the flow of funds," Proceedings, Federal Reserve Bank of Dallas, Federal Reserve Bank of Dallas, issue Apr.
  11. James H. Stock & Mark W. Watson, 2001. "Vector Autoregressions," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 15(4), pages 101-115, Fall.
  12. Pesaran, M. H., 1981. "Identification of rational expectations models," Journal of Econometrics, Elsevier, Elsevier, vol. 16(3), pages 375-398, August.
  13. Cooley, Thomas F. & Leroy, Stephen F., 1985. "Atheoretical macroeconometrics: A critique," Journal of Monetary Economics, Elsevier, Elsevier, vol. 16(3), pages 283-308, November.
  14. Garfinkel, Michelle R & Thornton, Daniel L, 1995. "The Information Content of the Federal Funds Rate: Is It Unique?," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 27(3), pages 838-47, August.
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Cited by:
  1. Marco Lippi & Daniel L. Thornton, 2004. "A dynamic factor analysis of the response of U. S. interest rates to news," Working Papers, Federal Reserve Bank of St. Louis 2004-013, Federal Reserve Bank of St. Louis.
  2. Ida Wolden Bache, 2006. "Assessing the structural VAR approach to exchange rate pass-through," Computing in Economics and Finance 2006, Society for Computational Economics 309, Society for Computational Economics.
  3. Fratzscher, Marcel & Juvenal, Luciana & Sarno, Lucio, 2009. "Asset Prices, Exchange Rates and the Current Account," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7614, C.E.P.R. Discussion Papers.
  4. Luciana Juvenal, 2009. "Sources of exchange rate fluctuations: are they real or nominal?," Working Papers, Federal Reserve Bank of St. Louis 2009-040, Federal Reserve Bank of St. Louis.
  5. Gultekin Isiklar, 2005. "Structural VAR identification in asset markets using short-run market inefficiencies," Econometrics, EconWPA 0501001, EconWPA, revised 02 Jan 2005.
  6. Andreas Lehnert & Wayne Passmore & Shane M. Sherlund, 2006. "GSEs, mortgage rates, and secondary market activities," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2006-30, Board of Governors of the Federal Reserve System (U.S.).

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