Local projections vs. VARs: Lessons from thousands of DGPs

Dake Li, Mikkel Plagborg-Møller, Christian K. Wolf

Research output: Contribution to journalArticlepeer-review

2 Scopus citations

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.

Original languageEnglish (US)
Article number105722
JournalJournal of Econometrics
DOIs
StateAccepted/In press - 2024

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics
  • Applied Mathematics

Keywords

  • External instrument
  • Impulse response function
  • Local projection
  • Proxy variable
  • Structural vector autoregression

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