Question
Consider the following vector autoregressive model where y t is a p 1 vector of variables determined by k lags of all p variables in
Consider the following vector autoregressive model
where y
t
is a p 1 vector of variables determined by k lags of all p variables in the system, u
t
is a
p1 vector of error terms, 0 is a p1 vector of constant term coefficients and
i
are p p matrices
of coefficients on the
i
th lag of y.
(a)
If p = 2, and k = 3, write out all the equations of the VAR in full, carefully defining any new
notation you use that is not given in the question.
(b) Why have VARs become popular for application in economics and finance, relative to structural
models derived from some underlying theory?
(c) Discuss any weaknesses you perceive in the VAR approach to econometric modelling.
(d) Two researchers, using the same set of data but working independently, arrive at different lag
lengths for the VAR equation (7.99). Describe and evaluate two methods for determining which of
the lag lengths is more appropriate.
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