Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 271: Un-truncating VARs

Ferre De Graeve () and Andreas Westermark ()
Additional contact information
Ferre De Graeve: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Andreas Westermark: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Abstract: Macroeconomic research often relies on structural vector autoregressions to uncover empirical regularities. Critics argue the method goes awry due to lag truncation: short lag-lengths imply a poor approximation to DSGE-models. Empirically, short lag-length is deemed necessary as increased parametrization induces excessive uncertainty. The paper shows that this argument is incomplete. Longer lag-length simultaneously reduces misspecification, which in turn reduces variance. For data generated by frontier DSGE-models long-lag VARs are feasible, reduce bias and variance, and have better coverage. Thus, contrary to conventional wisdom, the trivial solution to the critique actually works.

Keywords: VAR; SVAR; Lag-length; Truncation

JEL-codes: C18; E37

28 pages, June 1, 2013

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