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Qual VAR Revisited: Good Forecast, Bad Story

  • Makram El-Shagi
  • Gregor von Schweinitz

Due to the recent financial crisis, the interest in econometric models that allow to incorporate binary variables (such as the occurrence of a crisis) experienced a huge surge. This paper evaluates the performance of the Qual VAR, i.e. a VAR model including a latent variable that governs the behavior of an observable binary variable. While we find that the Qual VAR performs reasonably well in forecasting (outperforming a probit benchmark), there are substantial identification problems. Therefore, when the economic interpretation of the dynamic behavior of the latent variable and the chain of causality matter, the Qual VAR is inadvisable.

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Paper provided by Halle Institute for Economic Research in its series IWH Discussion Papers with number 12.

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Date of creation: Dec 2012
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Handle: RePEc:iwh:dispap:12-12
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