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Local Projections vs. VARs for structural parameter estimation

Author

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  • Castellanos, Juan

    (Bank of England)

Abstract

This paper conducts a Monte Carlo study to examine the small sample performance of impulse response (IRF) matching and Indirect Inference estimators that target IRFs that have been estimated with Local Projections (LP) or Vector Autoregressions (VAR). The analysis considers various identification schemes for the shocks and several variants of LP and VAR estimators. Results show that the lower bias from LP responses is a big advantage when it comes to IRF matching, while the lower variance from VAR is desirable for Indirect Inference applications as it is robust to the higher bias of VAR-IRFs. Overall, I recommend the use of Indirect Inference over IRF matching when estimating Dynamic Stochastic General Equilibrium (DSGE) models as the former is robust to potential misspecification coming from invalid identification assumptions, small sample issues or incorrect lag selection.

Suggested Citation

  • Castellanos, Juan, 2025. "Local Projections vs. VARs for structural parameter estimation," Bank of England working papers 1116, Bank of England.
    • Handle: RePEc:boe:boeewp:1116
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    References listed on IDEAS

    as
    1. Chari, V.V. & Kehoe, Patrick J. & McGrattan, Ellen R., 2008. "Are structural VARs with long-run restrictions useful in developing business cycle theory?," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1337-1352, November.
    2. Ruge-Murcia, Francisco J., 2007. "Methods to estimate dynamic stochastic general equilibrium models," Journal of Economic Dynamics and Control, Elsevier, vol. 31(8), pages 2599-2636, August.
    3. Òscar Jordà & Sharon Kozicki, 2011. "Estimation And Inference By The Method Of Projection Minimum Distance: An Application To The New Keynesian Hybrid Phillips Curve," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 52(2), pages 461-487, May.
    4. Mikkel Plagborg‐Møller & Christian K. Wolf, 2021. "Local Projections and VARs Estimate the Same Impulse Responses," Econometrica, Econometric Society, vol. 89(2), pages 955-980, March.
    5. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, September.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    DSGE estimation; impulse responses; Indirect Inference; Local Projection; Vector Autoregression; Monte Carlo analysis;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • E00 - Macroeconomics and Monetary Economics - - General - - - General

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