Local projections vs. VARs: Lessons from thousands of DGPs

Dake Li, Mikkel Plagborg-Moller and Christian K. Wolf

Journal of Econometrics, 2024, vol. 244, issue 2

Abstract: We conduct a simulation study of Local Projection (LP) and Vector Autoregression (VAR) estimators of structural impulse responses across thousands of data generating processes, designed to mimic the properties of the universe of U.S. macroeconomic data. Our analysis considers various identification schemes and several variants of LP and VAR estimators, employing bias correction, shrinkage, or model averaging. A clear bias–variance trade-off emerges: LP estimators have lower bias than VAR estimators, but they also have substantially higher variance at intermediate and long horizons. Bias-corrected LP is the preferred method if and only if the researcher overwhelmingly prioritizes bias. For researchers who also care about precision, VAR methods are the most attractive—Bayesian VARs at short and long horizons, and least-squares VARs at intermediate and long horizons.

Keywords: External instrument; Impulse response function; Local projection; Proxy variable; Structural vector autoregression (search for similar items in EconPapers)
JEL-codes: C32 C36 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Related works:
Working Paper: Local Projections vs. VARs: Lessons From Thousands of DGPs (2022)
Working Paper: Local Projections vs. VARs: Lessons From Thousands of DGPs (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:244:y:2024:i:2:s030440762400068x

DOI: 10.1016/j.jeconom.2024.105722

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