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Comparing External and Internal Instruments for Vector Autoregressions

Author

Listed:
  • Martin Bruns

    (School of Economics, University of East Anglia)

  • Helmut Lutkepohl

    (DIW Berlin and Freie Universitat Berlin)

Abstract

In conventional proxy VAR analysis, the shocks of interest are identified by external instruments. This is typically accomplished by considering the covariance of the instruments and the reduced-form residuals. Alternatively, the instruments may be internalized by augmenting the VAR process by the instruments or proxies. These alternative identification methods are compared and it is shown that the resulting shocks obtained with the alternative approaches differ in general. Conditions are provided under which their impulse responses are nevertheless identical. If the conditions are satisfied, identification of the shocks is ensured without further assumptions. Empirical examples illustrate the results and the virtue of using the identification conditions derived in this study.

Suggested Citation

  • Martin Bruns & Helmut Lutkepohl, 2025. "Comparing External and Internal Instruments for Vector Autoregressions," University of East Anglia School of Economics Working Paper Series 2025-01, School of Economics, University of East Anglia, Norwich, UK..
  • Handle: RePEc:uea:ueaeco:2025-01
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    References listed on IDEAS

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    More about this item

    Keywords

    Structural vector autoregression; proxy VAR; augmented VAR; fundamental shocks; invertible VAR;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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