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Are Small-Scale SVARs Useful for Business Cycle Analysis? Revisiting Non-Fundamentalness

Canova, Fabio; Sahneh, Mehdi Hamidi
Working paper
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URI
http://hdl.handle.net/11250/2429259
Date
2016
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  • Centre for Applied Macro- and Petroleum economics (CAMP) [124]
Abstract
Non-fundamentalness arises when observables do not contain enough information to recover the vector of structural shocks. Using Granger causality tests, the literature suggested that many small scale VAR models are non-fundamental and thus not useful for business cycle analysis. We show that causality tests are problematic when VAR variables are cross sectionally aggregated or proxy for non-observables. We provide an alternative testing procedure, illustrate its properties with a Monte Carlo exercise, and reexamine the properties of two prototypical VAR models.
Publisher
BI Norwegian Business School
Series
CAMP Working Paper Series;2/2016

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