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Explosive Roots in Level Vector Autoregressive Models

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  • Hammad Qureshi

    () (Department of Economics, Ohio State University)

Abstract

Level vector autoregressive (VAR) models are used extensively in empirical macroeconomic research. However, estimated level VAR models may contain explosive roots, which is at odds with the widespread consensus among macroeconomists that roots are at most unity. This paper investigates the frequency of explosive roots in estimated level VAR models in the presence of stationary and nonstationary variables. Monte Carlo simulations based on datasets from the macroeconomic literature reveal that the frequency of explosive roots exceeds 40% in the presence of unit roots. Even when all the variables are stationary, the frequency of explosive roots is substantial. Furthermore, explosion increases significantly, to as much as 100% when the estimated level VAR coefficients are corrected for small-sample bias. These results suggest that researchers estimating level VAR models on macroeconomic datasets encounter explosive roots, a phenomenon that is contrary to common macroeconomic belief, with a very high frequency. Monte Carlo simulations in the paper reveal that imposing unit roots in the estimation can substantially reduce the frequency of explosion. Hence one way to mitigate explosive roots is to estimate vector error correction models.

Suggested Citation

  • Hammad Qureshi, 2008. "Explosive Roots in Level Vector Autoregressive Models," Working Papers 08-02, Ohio State University, Department of Economics.
  • Handle: RePEc:osu:osuewp:08-02
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    File URL: http://www.econ.ohio-state.edu/pdf/qureshi/wp08-02.pdf
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    References listed on IDEAS

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    Cited by:

    1. Weichun Chen & Judith A. Clarke & Nilanjana Roy, 2014. "Health and wealth: Short panel Granger causality tests for developing countries," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 23(6), pages 755-784, September.

    More about this item

    Keywords

    Level VAR Models; Explosive Roots; Bias Correction;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange

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