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Forecasting Accuracy and Estimation Uncertainty using VAR Models with Short- and Long-Term Economic Restrictions: A Monte-Carlo Study

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Author Info
Osmani Teixeira de Carvalho Guillén (IBMEC Business School - Rio de Janeiro and Banco Central do Brasil)
João Victor Issler (Graduate School of Economics - EPGE, Getulio Vargas Foundation)
George Athanasopoulos (Department of Economics and Business Statistics, Monash University)

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Abstract

Using vector autoregressive (VAR) models and Monte-Carlo simulation methods we investigate the potential gains for forecasting accuracy and estimation uncertainty of two commonly used restrictions arising from economic relationships. The first reduces parameter space by imposing long-term restrictions on the behavior of economic variables as discussed by the literature on cointegration, and the second reduces parameter space by imposing short-term restrictions as discussed by the literature on serial-correlation common features (SCCF). Our simulations cover three important issues on model building, estimation, and forecasting. First, we examine the performance of standard and modified information criteria in choosing lag length for cointegrated VARs with SCCF restrictions. Second, we provide a comparison of forecasting accuracy of fitted VARs when only cointegration restrictions are imposed and when cointegration and SCCF restrictions are jointly imposed. Third, we propose a new estimation algorithm where short- and long-term restrictions interact to estimate the cointegrating and the cofeature spaces respectively. We have three basic results. First, ignoring SCCF restrictions has a high cost in terms of model selection, because standard information criteria chooses too frequently inconsistent models, with too small a lag length. Criteria selecting lag and rank simultaneously have a superior performance in this case. Second, this translates into a superior forecasting performance of the restricted VECM over the VECM, with important improvements in forecasting accuracy - reaching more than 100% in extreme cases. Third, the new algorithm proposed here fares very well in terms of parameter estimation, even when we consider the estimation of long-term parameters, opening up the discussion of joint estimation of short- and long-term parameters in VAR models.

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Paper provided by Economics Research Group, IBMEC Business School - Rio de Janeiro in its series IBMEC RJ Economics Discussion Papers with number 2006-01.

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Date of creation: 02 Jan 2006
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Handle: RePEc:ibr:dpaper:2006-01

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Related research
Keywords: reduced rank models; model selection criteria; forecasting accuracy;

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Find related papers by JEL classification:
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications

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References listed on IDEAS
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Bonomo, Marco Antônio Cesar & Terra, Maria Cristina T., 2005. "Special Interests and Political Business Cycles," Economics Working Papers (Ensaios Economicos da EPGE) 597, Graduate School of Economics, Getulio Vargas Foundation (Brazil). [Downloadable!]
  2. Cysne, Rubens Penha, 2006. "An Intra-Household Approach to the Welfare Costs of Inflation (Revised Version, Forthcoming 2006, Estudos Econômicos)," Economics Working Papers (Ensaios Economicos da EPGE) 612, Graduate School of Economics, Getulio Vargas Foundation (Brazil). [Downloadable!]
  3. Flôres Junior, Renato Galvão & Watanuki, Masakazu, 2006. "Integration Options for Mercosul - An Investigation Using the AMIDA Model," Economics Working Papers (Ensaios Economicos da EPGE) 610, Graduate School of Economics, Getulio Vargas Foundation (Brazil). [Downloadable!]
  4. Barbosa, Fernando de Holanda, 2005. "The Contagion Effect of Public Debt on Monetary Policy: The Brazilian Experience," Economics Working Papers (Ensaios Economicos da EPGE) 591, Graduate School of Economics, Getulio Vargas Foundation (Brazil). [Downloadable!]
  5. Cysne, Rubens Penha, 2006. "Income Inequality in a Job-Search Model With Heterogeneous Discount Factors (Revised Version, Forthcoming 2006, Revista Economia)," Economics Working Papers (Ensaios Economicos da EPGE) 611, Graduate School of Economics, Getulio Vargas Foundation (Brazil). [Downloadable!]
  6. Torres-Martínez, Juan Pablo & Araújo, Aloísio Pessoa de & Páscoa, Mario Rui, 2006. "Bubbles, Collateral and Monetary Equilibrium," Economics Working Papers (Ensaios Economicos da EPGE) 614, Graduate School of Economics, Getulio Vargas Foundation (Brazil). [Downloadable!]
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