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The importance of Common-Cyclical Features in VAR analysis: a Monte-Carlo study (Preliminary Version)

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  • Vahid, Farshid
  • Issler, João Pedro

Abstract

Despite the belief, supported byrecentapplied research, thataggregate datadisplay short-run comovement, there has been little discussion about the econometric consequences ofthese data 'features.' W e use exhaustive M onte-Carlo simulations toinvestigate theimportance ofrestrictions implied by common-cyclicalfeatures for estimates and forecasts based on vectorautoregressive and errorcorrection models. First, weshowthatthe'best' empiricalmodeldevelopedwithoutcommoncycles restrictions neednotnestthe'best' modeldevelopedwiththoserestrictions, duetothe use ofinformation criteria forchoosingthe lagorderofthe twoalternative models. Second, weshowthatthecosts ofignoringcommon-cyclicalfeatures inV A R analysis may be high in terms offorecastingaccuracy and e¢ciency ofestimates ofvariance decomposition coe¢cients. A lthough these costs are more pronounced when the lag orderofV A R modelsareknown, theyarealsonon-trivialwhenitis selectedusingthe conventionaltoolsavailabletoappliedresearchers. T hird, we…ndthatifthedatahave common-cyclicalfeatures andtheresearcherwants touseaninformationcriterium to selectthelaglength, theH annan-Q uinn criterium is themostappropriate, sincethe A kaike and theSchwarz criteriahave atendency toover- and under-predictthe lag lengthrespectivelyinoursimulations.

Suggested Citation

  • Vahid, Farshid & Issler, João Pedro, 1999. "The importance of Common-Cyclical Features in VAR analysis: a Monte-Carlo study (Preliminary Version)," FGV/EPGE Economics Working Papers (Ensaios Economicos da EPGE) 352, FGV/EPGE - Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  • Handle: RePEc:fgv:epgewp:352
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