VAR model

VECM models
SVAR model

VAR / VECM / SVAR models

Time Series Econometrics
14th May 2014

Karolina Konopczak

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Outline
1

VAR model
Introduction
Specication
Estimation and diagnostics
VECM models
Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model
SVAR model
SVAR vs. VAR model
Structural analysis
Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Plan prezentacji
1

VAR model
Introduction
Specication
Estimation and diagnostics
VECM models
Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model
SVAR model
SVAR vs. VAR model
Structural analysis
Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Introduction (1)
VAR (vector autoregressive) models were developed in the 1980s as an
alternative to multi-equation macroeconomic models (the Cowles
Commission approach) built in the 1950s and 1960s
Sims (1980) critique of the Cowles Commission approach:
ad-hoc specication
arbitrary (theory-based) endogenous/exogenous division of the
model variables
arbitrary (often inadequate) dynamic structure of the model
arbitrary assumptions of zero restrictions in order to pass the
identication conditions

forecasting inadequacy (become evident in the 1970s along with the

breakdown of the Bretton Woods system and oil crises)
disregard for the issue of unit roots / cointegration

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Introduction (2)

VAR models  basic characteristics:

atheoretical (no theoretical foundations)
unrestricted reduced form estimated (no identication problem)
no need for a priori distinction between exogenous and endogenous
variables (all variables are endogenous)
only lagged variables are used as explanatory variables > convenient tool
for forecasting
structural VAR (SVAR) models can be used for policy analysis

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Basic specication (1)

VAR(p):

yt =A0 Dt +A1 yt1 + A2 yt2 + ... + Ap ytp +Bxt + et

yt = [y1t yt 2 ... ytk ]T  k-dimensional vector of endogenous variables

Ai i = 1, ..., p  kxk-dimensional autoregressive coecient matrices
Dt  vector of deterministic variables
a constant
a linear trend
seasonal dummies
user-specied dummies

xt 

m-dimensional

vector of exogenous variables

et  k-dimensional vector of error terms

Karolina Konopczak

VAR / VECM / SVAR models

> for simplicity, we omit deterministic and exogenous variables:

yt =A1 yt1 + A2 yt2 + ... + Ap ytp + et
(mean-adjusted form of VAR(p))

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Basic specication (2)

VAR(p) model with

identical structure

endogenous variables consists of

equations of

in every equation p lags of endogenous variables are used as

explanatory variables (as well as deterministic variables)
the i-th equation
yit = a1,i 1 y1,t1 + a1,i 2 y2,t1 + ... + a1,ik yk,t1 +
+a2,i 1 y1,t2 + a2,i 2 y2,t2 + ... + a2,ik yk,t2 + ...
+ap,i 1 y1,tp + ap,i 2 y2,tp + ... + ap,ik yk,tp + eit

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Basic specication (3)

The k-dimensional vector of error terms full the following conditions:

et NID(0, e )
E (et etT ) = e (not restricted to be diagonal > possible
contemporaneous correlation)

contemporaneous correlation reects contemporaneous relations

between endogenous variables
T
E (et et+s
) = 0 for s 6= 0 (no serial correlation)

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Canonical representation
VAR(p) can be rewritten as VAR(1)
yt = A1 yt1 + A2 yt2 + ... + Ap ytp + et

yt
A1 A2 . . . Ap1 Ap
yt1 1
0
0
0

= .
..
..
..
..
.

.
.
.
.
.
ytp+1
0
0 ...
1
0
yt1 + ~
yt = A
et > canonical representation

A  companion matrix

yt1
yt2
..
.
ytp

of VAR(p)

e.g. VAR(2):
yt = A1 yt1 +
t

 A2 yt2 +e
 

yt
A1 A2
yt1
et
=
+
yt1
1
0
yt2
0

Karolina Konopczak

VAR / VECM / SVAR models

et

0
..
.
0

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

VARMA (Wold) representation

VAR(p):

yt = A1 yt1 + A2 yt2 + ... + Ap ytp + et

can be rewritten using lag

operator:

yt = A1 Lyt + A2 L2 yt + ... + Ap Lp yt + et
yt = A(L)yt + et ,

where

A(L) = A1 L + A2 L2 + ... + Ap Lp

assuming stability of VAR(p) we can derive vector moving average (VARMA)

representation:

(I A(L))yt = et
yt = (I A(L))1 et
yt = (I + A(L) + A(L)2 + ...)et
yt = et + C1 et1 + C2 et2+...
P
yt =
i=0 Ci eti
> yt expressed as a linear combination

of the current and past values of the

error term

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Estimation
since only lagged values of the endogenous variables appear on the
right-hand side of the equation, simultaneity bias is not as issue and OLS
yields consistent estimates
since error terms are contemporaneously correlated, seemingly unrelated
regression (SUR) estimator should be applied in order to yield ecient
estimates
but, since equations have the same set of regressors, SUR estimator
coincides with OLS estimator
in conclusion: parameters can be eciently estimated by OLS for every
equation separately
only if equations do not contain the same exogenous variables (e.g. have
dierent lag structures), SUR should be applied

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Lag order selection

determination of the lag length > a critical element in the specication

of a VAR model
overtting (too high lag length) > loss of degrees of freedom
> less precise parameter estimates
undertting (too small lag length) > possible serial correlation
> inconsistent parameter estimates

we should choose the model with the lowest lag length and residuals
which do not exhibit serial correlation
information

criteria

lag exclusion test

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Lag order selection  information criteria

information criteria take into account both goodness-of-t (determinant

e ) and parsimony
of variance-covariance matrix of the disturbance, det
(number of estimated parameters, K) of the model:
e ) + 2K
AIC = ln(det
T
e ) + K ln(T )
(SIC): SIC = ln(det

Akaike (AIC):
Schwarz

Hannan-Quinn (HQC):

e) +
HQC = ln(det

2K ln(ln(T ))
T

we choose the number of lags that minimises the criteria

the penalty for the number of parameters is the highest in the case of SIC
and the lowest in the case of AIC
> AIC tends to overestimate the true lag order while SIC tends to
underestimate it
> information criteria often give inconclusive results

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Lag order selection  lag exclusion test

lag exclusion test > a test of joint signicance of all endogenous variables at a
certain lag
sequential testing procedure:

(1)

(1)

H0

: Ap = 0

(2)

H0

: Ap1 = 0

...

(2)
(p)

vs.

(1)

H1

vs.

: Ap 6= 0

(2)

H1
(p)

: Ap1 6= 0

H0 : A1 = 0 vs. H1 : A1 6= 0
Ap = Ap1 = ... = A2 = 0
(p)

conditionally on

Ap = 0

conditionally on

the Likelihood Ratio test statistics:

Re ) ln(det
Ue )) 2kk , where:
LR = (T m)(ln(det
R  determinant of variance-covariance matrix of the disturbance (restricted model)
det
e
U  determinant of variance-covariance matrix of the disturbance (unrestricted model)
det
e
T  number of observations after accounting for lags
m number of parameters per equation of the unrestricted model

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Stability of a VAR model

a VAR model is stable if:

all roots of the characteristic polynomial (z ) have modulus greater
than one (lie outside the unit circle):
det(Ik A1 z A2 z 2 ... Ap z p ) = 0
or
all eigenvalues of the companion matrix (A ) have modulus less
than one (lie inside the unit circle)
or
all the endogenous variables are stationary

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Serial correlation (1)

in an autoregressive model serial correlation implies endogeneity bias and,

hence, inconsistent OLS estimator
Breusch-Godfrey autocorrelation test
Portmanteau autocorrelation test (Box-Pierce-Ljung-Box Q
statistics)

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Serial correlation (2)

Breusch-Godfrey test
H0 :

no serial correlation up to lag q [C1

= C2 = ... = Cq = 0]

et = B1 yt1 + B2 yt2 + ... + Bp ytp + C1 et1 + C2 et2 + ... + Cq etq + t

LR = T [logLR logLU ] 2qkk

Portmanteau Autocorrelation Test (Box-Pierce-Ljung-Box Q statistics)

H0 :

T )
no serial correlation up to lag q [E (et eti

Qq = T
where

Pq

j1

= 0 i = 1, ..., q

TRACE (CjT C01 Cj C01 )~2k 2 qn

T )
Cj = E (et etj

and n  number of estimated parameters

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Normality of residuals

normality of residuals is not required for OLS estimator to be BLUE, but

in nite samples it is necessary for valid hypotheses testing
multivariate version of the Jarque-Bera tests (comparing the 3rd and 4th
moments  skewness and kurtosis  to those from a normal distribution)
e.g. Doornik and Hansen test

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Potential solutions for non-gaussian disturbances

higher lag length

higher dimensions of the model (more endogenous variables)
introduction of dummy variables (accounting for outliers and structural
breaks)
but: degrees of freedom!

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Introduction
Specication
Estimation and diagnostics

Granger causality
yft is said to Granger-cause ygt if it contains useful information for
predicting
ygt

y1t

a11i

.
.
.

yft

ygt

..
.
ykt

p
P

af 1i
=

i=1 ag 1i

..

.
ak 1i

...

a1fi

a1gi

...

a1ki

.
.
.

.
.
.

.
.
.

.
.
.

.
.
.

...
...

affi
agfi

afgi
aggi

...
...

afki
agki

.
.
.

.
.
.

.
.
.

.
.
.

.
.
.

...

akfi

akgi

...

akki

i.e. agfi 6= 0 for at least one i (i p)

y1ti

e1t

.
.

yfti

ygti

.
ykti

.
.
.

eft
+
egt

..
.
ekt

restrictions can be tested using standard F-test:

F =

(RRSSURSS)/m
~
URSS/(T k)

Fm,T k ,

where

RRSS  restricted residuals sum of squares

URSS  unrestricted residual sum of squares

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Plan prezentacji
1

VAR model
Introduction
Specication
Estimation and diagnostics
VECM models
Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model
SVAR model
SVAR vs. VAR model
Structural analysis
Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Spurious regression (1)

Granger and Newbold (1974)
Let's consider two unrelated I(1) variables, y1t and y2t :
y1t = y1t1 + t with t iid(0, )
y2t = y2t1 + t with t iid(0,  )
E (t , s ) = 0 for every t,s
E (t , t+k ) = E (t , t+k ) = 0 for every

Let's regress y1t on y2t :

y1t = 0 + 1 y2t + t

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Spurious regression (2)

What do we expect?
1 to be statistically
R 2 to be close to 0

insignicant

What do we often get?

conventional tests (t, F) tend to indicate a statistically signicant
relationship
according to Monte Carlo simulations, the null hypothesis would be
(wrongly) rejected in 76% of cases using t-test at the 5% level
high

R2

+ low values of DW statistics

A why?
residuals in spurious regressions are highly correlated / integrated
> variance of residuals is not consistently estimated
> calculated t and F statistics do not follow t and F distributions

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Spurious regression (3)

How to handle nonstationary series?

remove stochastic trends by taking rst dierences and run regression on
dierenced variables
conventional test statistics follow their distributions
but: we lose information about long-run relationships between
variables
look for cointegration relationships
it turns out that SOME regressions on I(1) variables produce
meaningful results

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Cointegration (1)
Denition (2-dimensional case)
2-dimensional vector time series yt is said to be cointegrated of order (d,b) if
both component series, y1t and y2t , are integrated of order d but their linear
combination is integrated of order d-b:
0
yt CI (d, b) y1t I (d) y2t I (d) 6=0 y I (d b)
|{z}
y1 1 +y2 2

= [1 , 2 ]  cointegrating vector

not unique, i.e. for every non-zero scalar c: y T (c) I (d b)

in order to uniquely identify a normalization assumption is
required (usually 1 = 1)
we concentrate on d=b=1 case

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Cointegration (2)

Denition (k-dimensional case)

k-dimensional vector time series yt is said to be cointegrated of order (d,b) if
all component series are integrated of order d and there exists r<k linearly
0
independent 1xk vectors (1) ,..., (r ) such that y is integrated of order d-b,
(1)0
(r )0
where = [ , ..., ].
> the number of linearly independent cointegrating vectors is called the
cointegration rank

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Cointegration (3)

Testing for cointegration:

1 Two-step Engle-Granger procedure (Engle and Granger, 1987)
2 Johansen procedure (Johansen, 1988)

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Engle-Granger method (1)

Engle and Granger (1987) > 2-step residual-based cointegration test

1

Test for the order of integration of each series

If both series are I(1), estimate a static regression on their levels

(potential long-run equilibrium relationship) by OLS:
y1t = y2t + t
2t )
Generate a series of estimated residuals (t = y1t y

Test for cointegration test for the order of integration of t

if t is stationary, y1t and y2t are cointegrated with an estimated

cointegration vector = [1, ]

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Engle-Granger method (2)

Cointegrating Regression Dickey Fuller Test (CRDF)

t = t
1 (+

p
P

ti ) + t

i=1

H0 : t I (1) = 0
H1 : t I (0) < 0

CRDF =
S

> the CRDF test is the ADF test performed on estimated residuals (not true values)
> critical values dierent from those from the standard ADF test (MacKinnon, 1991)

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Engle-Granger method (3)

provided that the series are cointegrated, the OLS estimator is:
super-consistent (Stock, 1987)
> estimates converge in probability to the true value at a
faster-than-normal rate
> consistent even if the error term is correlated with the
explanatory variable (no asymptotic simultaneity bias)
not asymptotically normal
> standard errors and hence conventional statistics cannot be used
for statistical inference
often biased due to ignored dynamics (a static model is estimated)
> a serious problem in nite samples

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Error correction model

The Granger representation theorem

Cointegration implies the existence of the error correction
representation of the system.

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

ECM  derivation (1)

ADL(1,1,1):

yt = 0 + 1 yt1 + 0 xt + 1 xt1 + t
In equilibrium variables will have converged to the steady-state value:

yt = yt1 = y
xt = xt1 = x
Thus:

+1
0
+ 10
x
yt = 1
1
1

y t = 0 + 1 x
Interpretation:

0  short-run multiplier
+1
 long-run multiplier
1 = 10
1

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

ECM  derivation (2)

yt = 0 + 1 yt1 + 0 xt +
1 xt1 +yt1 yt1 + xt1 xt1 + 0 xt1 0 xt1 + 1 xt1 1 xt1 +t

ECM(1,1,1):
+1
0
10
x ) + 0 xt + t
yt = (1 1)(yt1 1
1
1 t1
yt = (yt1 0 1 xt1 ) + 0 xt + t
{z
}
|
ECT : t
1

= 1 1
<0

 the average speed of adjustment towards the long-run equilibrium

for EC mechanism to work

the larger (in absolute terms), the faster the convergence rate towards
equilibrium
all terms in the ECM are stationary (> standard statistical inference)

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Engle-Granger procedure  drawbacks

arbitrary normalization (estimates are asymptotically invariant to normalization

--> but small sample bias)
often biased estimates in small samples (due to ignored dynamics)
hypothesis testing about cointegration relationship not possible (due to not
normal distribution of OLS estimator)
arbitrary endogenous/exogenous division of the variables (variables may be
simultaneously determined)
if cointegration rank>1 the estimated cointegrating vector is a linear
combination of the true ones

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

VEC model (1)

vector error correction model (VECM)

=
vector equilibrium correction model (VEqCM)
=
cointegrated VAR model (CVAR)

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

VEC model (2)

Derivation:

yt = A1 yt1 + A2 yt2 + ... + Ap ytp + t +

+yt1 yt1 + (A1 I )yt2 (A1 I )yt2 +
+(A1 + A2 I )yt3 (A1 + A2 I )yt3 + ...

where yt is a k-dimensional I(1) vector time series

yt = yt1 +

Pp1
i=1

= (I
i =

Karolina Konopczak

i yti + t

Pp

i=1

Pp

j=i+1

Ai )
Aj

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Rank of the matrix (1)

all the endogenous variables in a VAR model are stationary

all roots of the characteristic polynomial

det(Ik A1 z A2 z 2 ... Ap z p ) = 0

have

modulus greater than one

at least one of the endogenous variables is non-stationary

characteristic polynomial

det(Ik A1 z A2 z 2 ... Ap z p ) = 0

has at least one unit

root (z=1)

det(Ik A1 A2 ... Ap ) = det() = 0

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Rank of the matrix (2)

det() = 0

det() = 0

at least one eigenvalue of

=0

has reduced rank

2 possibilities:
(1)

(2) rank(

=0 > the system non-stationary, but not cointegrated

)=r<k > there are r cointegrating relations in the system

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Rank of the matrix (3)

Q
rank( ) = number of non-zero eigenvalues = number of cointegrating vectors

testing for the number of cointegrating vectors

=
nding the number of eigenvalues that are signicantly dierent from zero

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Rank of the matrix (4)

Q
rank( )=k (full rank)

the system is stationary, i.e. all variables are stationary

we should estimate VAR in levels
Q
Q
rank( )=0 > =0
the system non-stationary, but not cointegrated
we should estimate VAR in rst dierences
Q
rank( )=r<k (reduced rank)
there are r cointegrating relations in the system
we should estimate VECM

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Johansen cointegration tests (1)

1 ,
2, ,
k  k eigenvalues of the estimated matrix (
) ordered

1 >
2 > >
k
such that

Johansen cointegration tests (trace, maximum eigenvalue) test for the

number of eigenvalues that are signicantly dierent from zero
non-standard distribution (> critical values: Johansen and Juselius,
1990)

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Johansen cointegration tests (2)

Trace statistics:
H0 : R = r
H1 : R > r
Pk
TRACE = T i=r +1 ln(1 i )
Maximum eigenvalue statistics:
H0 : R = r
H1 : R = r + 1
r +1 )
MAX = Tln(1

ln(1 i ) = 0 if i = 0,

since

ln(1) = 0

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Decomposition of the

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

matrix

Q
Q
if rank( )=r<k the
matrix can be decomposed into:
Q

= T

 matrix of cointegrating vectors (kxr)

 loading / adjustment matrix (kxr)
identication problem >Qmore parameters in and than
estimated parameters in

r 2 restrictions have to be imposed on the cointegrating vectors

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Hypotheses testing

Johansen procedure allows us to test hypotheses

Qabout cointegration
relationships in the form of restrictions on the
matrix
the restrictions can be imposed on:
cointegrating vectors
adjustment parameters (long-run causality)
short-run parameters (short-run causality causality)
The likelihood-ratio test of overidentifying restrictions
LR = T [logLR logLU ] 2m
U  unrestricted model
R  restricted model

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model

Cointegration and causality

the existence of cointegration implies long-run causality in at least

one direction between the variables in the system
i.e. at least one adjustment parameter (an element of ) must
be non-zero
k-th variable is weakly exogenous if k 1 = k 2 = ... = kr
k-th variable is strongly exogenous if it is weakly exogenous and is
not Granger-caused by other variables in the system

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

Plan prezentacji
1

VAR model
Introduction
Specication
Estimation and diagnostics
VECM models
Cointegration
Engle-Granger method / EC model
Johansen procedure / VEC model
SVAR model
SVAR vs. VAR model
Structural analysis
Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

SVAR vs. VAR model (1)

VAR model can be viewed as the reduced form of a dynamic simultaneous
equation model called structural VAR (SVAR)
SVAR: yt = B(L)yt + t , where
E (t Tt ) = I (no contemporaneous correlation)

VAR: yt = 1 B(L)yt + 1 t ( assuming is nonsingular)

yt = A(L)yt + et , where
A(L) = 1 B(L)
et = 1 t
E (et etT ) = e = E (1 t (1 t )T ) = E (1 t Tt (1 )T ) =
1 E (t Tt )(1 )T = 1 (1 )T
| {z }
I

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

SVAR vs. VAR model (2)

SVAR model:
structural ('true') model taking into account simultaneous relations
between endogenous variables
orthogonal disturbances (so-called structural shocks)
a response of endogenous variables to structural shocks can be
calculated and interpreted
but: due to simultaneity bias OLS estimator is inconsistent
VAR model:
reduced-form model
disturbances are a linear combination of structural disturbances:

et = 1 t

a response of endogenous variables to reduced-form disturbances

lack economic interpretation
no simultaneous relations > no simultaneity bias >
equation-by-equation OLS can be applied

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

Structural analysis

Estimate reduced-form model (VAR) by OLS

Given values of the reduced-form parameters solve for structural

parameters

Determine the response of endogenous variables to shocks

> impulse response function (IRF)

Determine the importance of dierent shocks in the total variance of each

endogenous variable
> forecast error variance decomposition (FEVD)

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

Identifying restrictions
without additional assumptions (identifying restrictions) structural
parameters cannot be derived (dierent structural models can be
transformed into the same reduced form)
number of restrictions equals the dierence between the number of
parameters of SVAR and of VAR
n(n + 1)
VAR: pn2 +
|{z} | {z
2 }
pAi

SVAR: pn2 + |{z}

n2
|{z}
pBi

n(n + 1)
pn + n pn2
=
|{z} |{z} |{z} | {z
2 }

pB
pA
2
i

n(n1)

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

Short-run identication /simplied version/ (1)

proposed by Sims (1980)

based on the so-called Cholesky decomposition (factorisation):
every symmetric positive-denite matrix can be decomposed in
the following way:
=
PP T , where P is a lower-triangular matrix:
0 ... 0
0

P= . .
.
.. .. ..

"
#


a q 0
a b
e.g. =
> P = Chol() =
b2
b

c d
d
a
a

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

Short-run identication /simplied version/ (2)

Cholesky decomposition is applied to the reduced form covariance matrix,

E (et etT ) = e
1 = Chol(
e)
e = 1 (1 )T >
Cholesky decomposition implies recursive relations between endogenous
variables
results are ordering-dependent

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

Short-run identication

in general case
we have SVAR: yt = B(L)yt + t , where E (t T
t ) = ( 
diagonal matrix)
we use triangular (not Cholesky) factorisation

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

Other identication schemes

long-run restrictions (e.g. Blanchard and Quah, 1989)

non-recursive short-run restrictions (e.g. Blanchard and Perotti, 2002)
sign restrictions (e.g. Mountford and Uhlig, 2002)

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

Impulse Response Function (1)

Ci eti , where et = 1 t

P
P
d11i
SVARMA: yt =
=
i=
0
i=0 Di ti
|{z}
d21i

VARMA: yt =

i=0

where Di = 1 Ci
IRFknj =

yk
yn
tj

bivariate model

d12i
d22i



1
yti
2
yti

= dknj > how one-unit structural shock yn at time t

impacts the level of yk at time t+j

e.g. d111 = yy11 , d121 = yy21 , d211 =
t1

t1

y2
y1 ,
t
1

d221 =

y2
y2
t
1

since endogenous variables are stationary structural shocks fade away, i.e.
have no long-run impact on the level of yk :
lim dknj = 0
j

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

Impulse Response Function (2)

Cumulative (long-run)
impact of structural
shocks:
 P
 
P

P
d
d
d11
11
i
12
i
i=
0
i=
0
P
D(1) = i=0 Di = P
=
d31
i=0 d21i
i=0 d22i

Karolina Konopczak

d12
d32

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

Forecast Error Variance Decomposition (1)

Derivation (1):
SVARMA representation for yt+j :
yt+j = D0 t+j + D1 t+j1 + ... + Dj1 t+1 + Dj t + Dj+1 t1 + ...
the best linear forecast of yt+j based on information available at time t:
Eyt+j|t = Dj t + Dj+1 t1 + ...
forecast error:
P 1
yt+j Eyt+j|t = D0 t+j + D1 t+j1 + ... + Dj1 t+1 = j
i=0 Di t+ji

Karolina Konopczak

VAR / VECM / SVAR models

VAR model
VECM models
SVAR model

SVAR vs. VAR model

Structural analysis

Forecast Error Variance Decomposition (2)

Derivation (2):
forecast error for k-th endogenous variable:
yk,t+j Eyk,t+j|t =
Pj1
Pj1
Pj1
i=0 dk 1,i 1,t+ji +
i=0 dk 2,i 2,t+ji + ... +
i=0 dkm,i m,t+ji

variance of the forecast error for k-th endogenous variable:

2
k,j
= D 2 (yk,t+j Eyk,t+j|t ) =
P 1 2
2 Pj1 2
2 Pj1 2
1 i=0 dk 1,i + 22 j
i=0 dk 2,i + ... + m
i=0 dkm,i
where 2i denotes the variance of i-th structural shock

FEVD > the relative share of variance that n-th structural shock
contributes to the
forecast error variance of k-th variable:
Pjtotal
1 d2
2
FEVDknj = n i=20 kn,i
kj

Karolina Konopczak

VAR / VECM / SVAR models