Structural VARs, deterministic and stochastic trends: how much detrending matters for shock identification

Wiriyawit Varang and Benjamin Wong
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Wiriyawit Varang: Mahidol University International College, 999 Phutthamonthon 4 Road, Salaya, Nakhonpathom 73170, Thailand

Studies in Nonlinear Dynamics & Econometrics, 2016, vol. 20, issue 2, 141-157

Abstract: Detrending within structural vector autoregressions (SVAR) is directly linked to the shock identification. We investigate the consequences of trend misspecification in an SVAR using both standard real business cycle models and bi-variate SVARs as data generating processes. Our bias decomposition reveals biases arising directly from trend misspecification are not trivial when compared to other widely studied misspecifications. Misspecifying the trend also distorts impulse response functions of even the correctly detrended variable within the SVAR system. Pretesting for unit roots mitigates trend misspecification to some extent. We also find that while practitioners can specify high lag order VARs to mitigate trend misspecification, relying on common information criterion such as the Akaike information criterion (AIC) or Bayesian information criterion (BIC) may choose a lag order that is too low.

Keywords: bias; detrending; identification; structural VAR (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Structural VARs, deterministic and stochastic trends: Does detrending matter? (2015)
Working Paper: Structural VARs, Deterministic and Stochastic Trends: Does Detrending Matter? (2014)
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DOI: 10.1515/snde-2015-0030

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