1ournal of Forccasiing

1. Forccasi. 19, 161179 (2001)

Copyiigll 2001 1oln Wiley & Sons, Ild.
Impulse Response Analysis in Vector
Autoregressions with Unknown Lag
Order
LUTZ KILIAN
University of Michigan, USA, and CEPR, UK
ABSTRACT
We slow llal lle eecls ol oveillling and undeillling a vecloi aulo-
iegiessive (VAR) model aie sliongly asymmeliic loi VAR summaiy slal-
islics involving liglei-oidei dynamics (sucl as impulse iesponse lunclions,
vaiiance decomposilions, oi long-iun loiecasls). !ndeill models ollen
undeieslimale lle liue dynamics ol lle populalion piocess and may iesull
in spuiiously ligll conldence inleivals. Tlese insiglls aie impoilanl loi
applied woil, iegaidless ol low lle lag oidei is deleimined. !n addilion,
lley piovide a new peispeclive on lle liade-os Lelween alleinalive lag
oidei seleclion ciileiia. We piovide evidence llal, conliaiy lo convenlional
wisdom, loi many slalislics ol inleiesl lo VAR useis lle poinl and inleival
eslimales Lased on lle A!C compaie lavouiaLly lo llose Lased on lle
moie paisimonious Sclwaiz !nloimalion Ciileiion and HannanQuinn
Ciileiion. Copyiigll 2001 1oln Wiley & Sons, Ild.
KEY WORDS VAR; lag oidei seleclion; model unceilainly; Loolsliap
Mucl ol wlal we lnowaLoul macioeconomic dynamics is Lased on summaiy slalislics calculaled
liom eslimales ol vecloi-auloiegiessive (VAR) models. Tlese dynamics ciucially depend on lle
lag oidei cloice, Lecause lle slalislics ol inleiesl aie lunclions ol lle oidei ol lle auloiegiessive
lag polynomial. !n llis papei, il is aigued llal lle eecls ol oveillling and undeillling lle VAR
model aie sliongly asymmeliic loi VAR summaiy slalislics involving liglei-oidei dynamics
(sucl as impulse iesponse lunclions, vaiiance decomposilions, oi long-iun loiecasls). !l is slown
llal undeill models lend lo undeieslimale lle liue dynamics ol lle populalion piocess and may
iesull in spuiiously ligll conldence inleivals. Tlese insiglls aie impoilanl loi applied woil,
iegaidless ol low lle lag oidei is deleimined liom lle dala. !n addilion, lley piovide a new
peispeclive on lle liade-os Lelween lag oidei seleclion ciileiia.
Alllougl il is common in applied woil lo deleimine lle VARlag oidei Lased on inloimalion-
Lased lag oidei seleclion ciileiia (see isli, 1988; Giangei, King, and Wlile, 1995; Sin and
Wlile, 1996), lo dale veiy lillle is lnown aLoul lle implicalions ol alleinalive lag oidei seleclion
pioceduies loi eslimalion and inleience. Tlis gap in lle lileialuie is suipiising, given lle gieal
impoilance allacled lo lle suLslanlive conclusions liom vecloi auloiegiessions. !l is widely
Coiiespondence lo: Iulz Kilian, Depailmenl ol Lconomics, !niveisily ol Micligan, Ann AiLoi, M! 48109-1220,
!SA. L-mail: llilianumicl.edu
162 1. Kilian
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
Lelieved llal sliongly consislenl lag oidei seleclion ciileiia sucl as lle Sclwaiz !nloimalion
Ciileiion (S!C) and lle HannanQuinn Ciileiion (HQC) aie Lellei suiled loi lle analysis ol
lnile-lag oidei VAR models llan lle less paisimonious Alaile !nloimalion Ciileiion (A!C). !n
conliasl, loi inlnile-oidei auloiegiessions, lle A!C is iegaided as moie appiopiiale. !n llis
papei, lle case is made llal cvcn in lnile-oidei VAR models loi many slalislics ol inleiesl lo
VAR useis lle use ol lle A!C lends lo iesull in moie accuiale poinl and inleival eslimales.
Pievious sludies ol lle lag oidei cloice in lnile-lag oidei VAR models lenlalively concluded
llal lle S!C peiloims Lesl in small samples. Tlal conclusion was Lased on simulalion evidence
aLoul lle disliiLulion ol lle lag oidei eslimales and aLoul lle sloil-iun loiecasling peiloimance
ol lle eslimaled VAR model (e.g. iclelsLuig, 1985; Iu llepoll, 1985, 1991). Lvidence loi ollei
slalislics ol inleiesl sucl as impulse iesponse lunclions, vaiiance decomposilions, measuies ol
piediclaLilily, oi long-leim loiecasls appaienlly las nol Leen piesenled. Tlis papei lales lle
view llal lle lallei slalislics diei in impoilanl ways liom sloil-iun loiecasls. oi example,
impulse iesponse lunclions can Le llougll ol as cuives well appioximaled Ly liglei-oidei
polynomials. !ndeillling lle lag oidei amounls lo appioximaling llese cuives Ly lowei-oidei
polynomials. Consequenlly, mucl ol lle cuivaluie ol lle impulse iesponse lunclion is eeclively
eiased, iesulling in misleading eslimales and inleience. !n conliasl, oveillling only iesulls in less
piecise eslimales ol lle impulse iesponse lunclion. Tlus, lle eecls ol oveillling and undeillling
lle model aie sliongly asymmeliic, especially al long lime loiizons, and lle ielalive peiloimance
ol lle lag oidei seleclion ciileiia may diei suLslanlially liom lle iesulls iepoiled loi sloil-iun
loiecasls. Tle lacl llal lle cosls associaled will undeillling lle model lend lo Le dis-
piopoilionalely laigei suggesls llal less paisimonious lag oidei seleclion ciileiia sucl as lle A!C
may iesull in moie accuiale impulse iesponse eslimales compaied lo lle liglly paisimonious
S!C and HQC.
A Monle Cailo sludy illusliales llal, in lle piesence ol liglei-oidei dynamics in impulse
iesponse lunclions, lle A!C indeed las Lellei lnile-sample piopeilies llan moie paisimonious
lag oidei seleclion ciileiia. Tle simulalion sludy compaies lle peiloimance ol loui well-lnown
inloimalion-Lased lag oidei seleclion ciileiia Lased on: (1) lle small-sample disliiLulion ol lle
lag oidei eslimales; (2) lle mean squaied eiiois ol lle implied impulse iesponse poinl eslimales;
and (3) lle coveiage accuiacy and aveiage lengll ol lle implied impulse iesponse conldence
inleivals. Tle lallei pail ol lle papei Luilds on a iecenl sludy ol Kilian (1998a) wlicl compaied
vaiious conldence inleivals loi VAR impulse iesponses undei lle assumplion llal lle lag oidei
is lnown, and concluded llal Lias-coiiecled non-paiameliic Loolsliap inleivals lend lo Le mosl
accuiale in small samples. A desciiplion ol lle algoiillm is piovided in lle Appendix.
Tle iemaindei ol lle papei is oiganized as lollows. Tle nexl seclion Liiey ieviews lle lag
oidei seleclion ciileiia used in lle simulalion sludy. Tle design ol lle Monle Cailo sludy is
explained in lle lliid seclion. Tle louill seclion conlains a summaiy ol lle simulalion iesulls.
Tle llll seclion ielales lle lndings lo lle exisling lileialuie on lag oidei seleclion, and lle
sixll seclion conlains an example ol low lle dieiences Lelween lle Alaile and lle Sclwaiz
!nloimalion Ciileiion may aecl lle suLslanlive inleipielalion ol macioeconomic VAR models.
!n lle lnal seclion we summaiize lle iesulls and oulline seveial exlensions.
IAG ORDLR SLILCT!O CR!TLR!A OR VLCTOR A!TORLGRLSS!OS
Considei a covaiiance slalionaiy N-dimensional VAR piocess will lnile lag oidei p
0
and iid
disluiLances u
i
will vecloi mean zeio and unlnown posilive delnile covaiiance maliix S
u
:
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
Inpulsc Tcsponsc Hnalysis in 1HTs 163
y
i
B
1
y
i1
B
2
y
i2
. . . B
p
y
ip
0
u
i
(1)
Iel bvcc(B
1
, B
2
, . . . , B
p
0
) and svcch(S
u
), wleie vcc denoles lle column slacling opeialoi
and vcch is lle column slacling opeialoi llal slacls lle elemenls on and Lelow lle diagonal
only. Tle slalislic ol inleiesl is lle eslimaled iesponse ol vaiiaLle k lo a one-lime impulse in
vaiiaLle l, i peiiods ago, denoled Ly u
kl,i
(b , s

, p`) wleie p` is an eslimaloi ol p

0
(see Iu llepoll,
1991, loi luillei discussion).
!n piaclice, p` musl Le deleimined liom lle dala. !l is common lo use inloimalion-Lased lag
oidei seleclion ciileiia loi llis puipose. We considei loui sucl ciileiia, wlicl diei Ly lle
seveiily ol lle penally imposed loi paiamelei pioigacy and lence in lle paisimony ol lle model
selecled: lle Sclwaiz !nloimalion Ciileiion (S!C), lle HannanQuinn Ciileiion (HQC), lle
Alaile !nloimalion Ciileiion (A!C), and lle Lias-coiiecled Alaile !nloimalion Ciileiion
(A!C
BC
) ol Huivicl and Tsai (1993). Tle A!C
BC
is a modilcalion ol lle A!C designed lo Liidge
lle middle giound Lelween lle HQC and lle A!C Ly ieducing lle A!C`s lendency lo oveill in
small samples. oi an N-dimensional VAR(p) piocess willoul deleiminislic componenls:
SIC(p) ln = S
u
(p) =
lnT
T
(N
2
p)
HQC(p) ln = S
u
(p) =
2 lnlnT
T
(N
2
p)
(2)
HIC(p) ln = S
u
(p) =
2
T
(N
2
p)
HIC
BC
(p) T(ln = S
u
(p) = N) 2b"N
2
p N(N1),2#
wleie T is lle eeclive sample size, S
u
lle maximum lilelilood eslimale ol S
u
, and lle Lias-
coiieclion lacloi loi lle A!C
BC
is b T,"T(pNN1)#. !n eacl case, lle lag oidei p` is
closen lo minimize lle value ol lle ciileiion ovei a iange ol alleinalive lag oideis p given Ly
"p: 1 p p#. !l is assumed llal lle liue lag oidei p
0
is conlained in llis sel. Oui ullimale goal
is lo use eslimales p` lo consliucl poinl and inleival eslimales loi u
kl,i
(b , s , p`).
Only lle S!C and HQC aie sliongly consislenl loi p
0
(see Quinn, 1980, p. 182), Lul all loui
ciileiia imply consislenl eslimales ol u
kl,i
(b, s, p
0
). oi luillei discussion see SliLala (1976, 1980),
Hannan and Quinn (1979), Quinn (1980), Paulsen and Tjo slleim (1985), SliLala (1986), Quinn
(1988), Po lsclei (1991, 1995), and KaLaila (1995). Alllougl lle A!C will lend lo oveieslimale
p
0
, lle asymplolic pioLaLilily llal lle A!C selecls lle liue lag oidei is 0.880.89 loi Livaiiale
piocesses, aLoul 0.96 loi liivaiiale piocesses, 0.99 loi dimension 4, and 0.998 loi dimension 5
(see Paulsen and Tjo slleim, 1985). Tlis means llal lle asymplolic pioLaLilily ol oveieslimaling
lle lag oidei can Le salely neglecled in mosl mullivaiiale applicalions.
An impoilanl diawLacl ol sliongly consislenl lag oidei seleclion ciileiia is llal lley lave a
lendency lo undeieslimale lle liue lag oidei in small samples. As a iesull, lle implied paiamelei
vecloi need nol conveige uniloimly lo lle liue paiamelei vecloi (see KaLaila, 1995; Po lsclei,
1995). We conjecluie llal, in piaclice, llis lendency lo undeill may iesull in seveie mis-
specilcalion Lias loi VAR slalislics lile impulse iesponses, especially al liglei loiizons. Tle
piaclical impoilance ol llis pioLlem, lowevei, is nol oLvious Lecause Liased eslimales lend lo
lave lowei vaiiance llan unLiased eslimales. !n many inslances a ieseaiclei may pielei a Liased
eslimale, piovided lle MSL is ieduced. !l llus seems naluial lo compaie lle peiloimance ol
164 1. Kilian
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
alleinalive lag-oidei seleclion ciileiia in leims ol lle MSLol lle paiamelei eslimaloi u
kl,i
(b , s , p`).
Tle Monle Cailo sludy Lelow will examine lle Liasvaiiance liadeo in giealei delail.
S!M!IAT!O DLS!G
Tle populalion piocess undeilying lle Monle Cailo sludy is designed lo pioduce impulse
iesponse lunclions will slapes claiacleiislic ol impulse iesponse lunclions encounleied in
applied woil, nolaLly lle exislence ol liglei-oidei dynamics in lle impulse iesponse lunclions.
Tle dala-geneialing piocess is a Livaiiale VAR(4) will coemcienl maliices:
B
1

$
0.6362 0.0012
0.0190 0.5782%
B
2

$
0.0168 0.0285
0.5211 0.3041%
(3)
B
3

$
0.0273 0.0028
0.1568 0.2229%
B
4

$
0.1517 0.0198
0.7600 0.3168%
will a dominanl iool ol 0.8894. Tle iid innovalions aie noimally disliiLuled will vecloi mean
zeio and vaiiancecovaiiance maliix S
u
:
S
u

$
0.025 0.009
0.009 0.387%
10
3
(4)
Tlis pailiculai piocess was closen loi lwo ieasons: (1) ils impulse iesponse lunclions aie
similai in slape lo iesponses llal migll Le encounleied in laigei syslems sucl as lle empiiical
example given lalei; (2) lle piocess is peisislenl, Lul ils dominanl iool is small enougl lo allow
us lo aLsliacl liom any complicalions llal may aiise in models will iools close lo unily. !n
piaclice, inleiesl ollen cenlies on VAR models eslimaled suLjecl lo coinlegialion consliainls.
We do nol addiess lle suLjecl ol coinlegialion in llis papei Lecause il is nol cenlial lo oui poinl.
Tle puipose ol lle Monle Cailo sludy is lo illusliale lle polenlial quanlilalive impoilance ol
lle Liasvaiiance liadeo in as simple a selling as possiLle. Acompielensive sludy ol alleinalive
models and eslimalois would moie appiopiialely Le lle suLjecl ol a sepaiale sludy.
Based on diaws liomllis dala-geneialing piocess, we compaie lle MSLs ol lle oillogonalized
impulse iesponse poinl eslimales u
kl,i
(b , s , p`) loi eacl ol lle loui lag-oidei seleclion ciileiia
discussed eailiei. We also evaluale lle eeclive coveiage accuiacy and aveiage lengll ol lle
coiiesponding nominal 95" Loolsliap conldence inleivals. Leclive coveiage is delned as lle
ielalive liequency will wlicl lle conldence inleival coveis lle liue, Lul in piaclice unlnown,
impulse iesponse value in iepealed liials.
Tle inleivals aie oLlained Ly condilioning on lle eslimaled lag oidei, as llougl il weie lle
liue lag oidei. As a slandaid ol compaiison, lle counleilaclual inleival llal would Le oLlained,
il lle liue lag oidei weie lnown, is also included. By consliuclion lle liue lag oidei ol lle
piocess is p
0
4. !n lle Monle Cailo sludy, lle lag oidei is eslimaled undei lle mainlained
assumplion llal 1 p 8. Tlis assumplion is lilely lo lavoui paisimonious ciileiia lile lle S!C
Ly pievenling llem liom selecling p` 0. Tle numLei ol Monle Cailo liials is 400, implying a
Monle Cailo slandaid eiioi ol 0.01 loi lle 95"inleival, and lle numLei ol Loolsliap ieplicalions
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
Inpulsc Tcsponsc Hnalysis in 1HTs 165
is 2000. Tle sample sizes aie 80 and 160, wlicl may Le llougll ol as lwenly and loily yeais ol
quaileily dala.
S!M!IAT!O RLS!ITS
Lag order estimates
!l is well lnown llal consislenl lag oidei seleclion ciileiia aie moie lilely lo undeieslimale lle
liue lag oidei llan lo oveieslimale il in lnile samples. !n conliasl, inconsislenl ciileiia sucl as
lle A!C lend lo Le moie Lalanced aLoul p
0
in small samples, will a lendency lo oveieslimale p
0
sligllly as lle sample size giows. We Legin Ly examining lle accuiacy ol llese claims loi lle
dala-geneialing piocess in equalions (3) and (4).
TaLle ! summaiizes lle lnile-sample disliiLulion ol p` loi eacl lag oidei seleclion ciileiion.
oi sample size 80, lle S!C undeieslimales lle liue lag oidei in 98" ol lle 400 liials. !n lacl,
will pioLaLilily 0.92 il picls a lag oidei ol one. Tlis sliong downwaid Lias ol lle S!C lag oidei
eslimaloi conlims llal lle S!C las mucl liglei iisl ol undeieslimaling lle lag oidei llan ol
oveieslimaling il. TaLle ! also slows llal lle S!C las almosl zeio pioLaLilily ol oveieslimaling
p
0
. !n conliacl, lle A!C lag oidei disliiLulion is iouglly cenlied on lle liue value. !l undei-
eslimales lle lag oidei will pioLaLilily 0.26 and oveieslimales il will pioLaLilily 0.18. As lle
sample size incieases lo 160, lle peiloimance ol Loll ciileiia impioves, Lul lle Lasic pallein is
pieseived. Tle S!C slill picls a lag oidei ol one will pioLaLilily 0.61, wleieas lle A!C selecls
lle liue lag oidei will pioLaLilily 0.83. !l is nolewoilly llal lle A!C undeieslimales lle lag
oidei in only lliee cases, and llal lle pioLaLilily ol oveieslimalion luillei declines will lle
sample size, consislenl will lle asymplolic iesulls ol Paulsen and Tjo slleim (1985). Tle lacl
llal in small samples lle A!C lag oidei disliiLulion lends lo Le moie Lalanced aLoul lle liue
lag oidei llan lle S!C lag oidei eslimales is consislenl will lndings Ly iclelsLuig (1985) and
Iu llepoll (1985, 1991) loi ollei dala-geneialing piocesses (see also SliLala, 1983).
Tle evidence in TaLle ! suppoils lle view llal lle S!C may Le exliemely unLalanced even loi
TaLle !. Peicenlage disliiLulion ol lag oidei eslimales Ly ciileiion
Iag oideis
Ciileiion 1 2 3 4 5 6 7 8
Sanplc si:c 80
S!C 92.0 5.8 0 2.0 0.3 0 0 0
HQC 54.3 11.3 1.3 30.3 2.8 0.3 0 0
A!C
BC
32.8 15.3 2.0 45.0 4.3 0.8 0 0
A!C 14.5 9.3 1.8 56.5 11.3 2.8 2.3 1.8
Sanplc si:c 160
S!C 60.8 11.5 0.3 27.5 0 0 0 0
HQC 7.8 4.3 0.3 84.5 3.3 0 0 0
A!C
BC
0.8 0.8 0.3 88.8 7.8 1.3 0.5 0
A!C 0.5 0 0.3 83.3 10.8 2.5 2.8 0
Sourcc
Resulls Lased on 400 Monle Cailo liials and lle dala-geneialing piocess desciiLed in lle louill seclion. Tle lag oideis
aie consliained lo lie Lelween 1 and 8. Tle liue lag oidei is p
0
4.
166 1. Kilian
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
sample size 160. !l llus seems sensiLle lo exploie less paisimonious alleinalives. Since lle HQC
is lle leasl paisimonious, yel slill consislenl, model seleclion ciileiion, one would expecl lle
HQC lo Le moie Lalanced and less downwaid Liased llan lle S!C. Tle Monle Cailo simulalions
conlim llal view. TaLle ! slows llal loi sample size 80 (160) lle HQC undeieslimales p
0
will pioLaLilily 0.67 (0.12) and oveieslimales p
0
will pioLaLilily 0.03 (0.03). Howevei, lle
peiloimance ol lle HQC inleival slill lalls lai sloil ol lle A!C inleival, especially loi sample
size 80. Tlis suggesls lo considei alleinalive ciileiia sucl as lle A!C
BC
llal Liidge lle middle
giound Lelween lle HQCand lle A!C. Tlis ciileiion was inlioduced Ly Huivicl and Tsai (1993,
p. 271) lo ieduce lle lendency ol lle A!C lo oveill in VAR models, especially in small samples.
TaLle ! slows llal lle A!C
BC
indeed ieduces lle lendency ol lle A!C lo oveill in small samples,
Lul al lle expense ol undeillling moie ollen. Given lle eailiei discussion, one would lleieloie
conjecluie llal A!C
BC
impulse iesponse eslimales ougll lo Le moie accuiale al longei loiizons
llan S!C oi HQC eslimales, Lul less accuiale llan A!C eslimales.
Impulse response point estimates
We now luin lo lle queslion ol low lle accuiacy ol lle impulse iesponse poinl eslimales is
aecled Ly lle cloice ol lag oidei seleclion ciileiion. Tle accuiacy ol lle poinl eslimales
u
kl,i
(b , s , p`) is evalualed in leims ol lleii mean-squaied devialion liom lle populalion value ol
lle impulse iesponse al eacl lime loiizon. iguies 1 and 2 plol lle iesulls loi sample size 80 and
160. To pul lle magnilude ol lle MSLs inlo peispeclive, lle plols also include iesulls undei lle
counleilaclual assumplion llal lle liue lag oidei is lnown. To assisl in lle inleipielalion ol lle
iesulls, lle lell column in eacl lguie slows lle undeilying populalion impulse iesponse lunclions
lo Le eslimaled. Tle slapes ol lle liue impulse iesponse lunclions involve vaiious degiees and
palleins ol liglei-oidei dynamics. Tley iepiesenl loui common palleins lound in applied woil.
iguies 1 and 2 slow llal, iegaidless ol lle slape ol lle impulse iesponse lunclion, lle A!C-
Lased eslimale oveiall las lle lowesl mean squaied eiioi, lollowed Ly lle A!C
BC
, HQC, and
S!C, in llal oidei. As lle sample size incieases, lle accuiacy ol all eslimales impioves, Lul lle
ielalive accuiacy ol lle S!C-Lased eslimales deleiioiales luillei. Tle ianling ol lle loui ciileiia
is exaclly as conjecluied, and lle dieiences in accuiacy can Le suLslanlial.
Tle magnilude ol lle MSL appeais closely linled lo lle cuivaluie ol lle populalion impulse
iesponse lunclion. ole lle lendency ol lle MSL ol lle S!C eslimale (and lo a lessei exlenl ol
lle ollei eslimales) lo oscillale as lle lime loiizon giows. Tlis lype ol pallein is wlal one would
expecl liomllling a smoollly decaying low-oidei polynomial lo lle populalion impulse iesponse
lunclions in lle lell column. Sucl oveismoolling ol lle impulse iesponse lunclion would also
accounl loi lle lacl llal in some cases lle MSL ol lle S!C eslimale lempoiaiily diops Lelow
llal ol lle eslimales Lased on lle A!C oi lle liue lag oidei. uillei indiiecl evidence llal
liglei-oidei dynamics aie diiving lle iesull is lle lacl llal in many cases lleie is lillle dieience
Lelween alleinalive lag oidei seleclion ciileiia al low lime loiizons. !n lwo cases, loi sample size
80, lle S!Ceslimale las suLslanlially lowei MSL in lle veiy sloil iun. Tlis evidence is consislenl
will eailiei lndings Ly Iu llepoll (1985, 1991) loi sloil-iun piediclion MSLs in somewlal
simplei VAR models. !l is also consislenl will lle aigumenl piesenled aLove llal lle adveise
eecls ol oveismoolling will only Lecome appaienl al liglei lime loiizons. Howevei, lle
advanlages ol lle S!C in lle veiy sloil iun disappeai loi modeiale samples and in all cases aie
dwailed Ly incieases in lle MSL al liglei lime loiizons.
iguies 1 and 2 conlim SliLala`s (1983) poinl llal consislency loi p
0
is nol necessaiily a
desiiaLle piopeily il we aie inleiesled in a good eslimaloi oi piedicloi. Iowei-oidei models
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
Inpulsc Tcsponsc Hnalysis in 1HTs 167

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Inpulsc Tcsponsc Hnalysis in 1HTs 169
Lased on paisimonious, consislenl model-seleclion ciileiia lend lo do ielalively well al veiy sloil
lime loiizons, Lul ollen pooily al liglei lime loiizons. !n conliasl, inconsislenl, Lul moie
Lalanced model seleclion ciileiia lend lo do well al all lime loiizons, even allei accounling loi
lle inciease in vaiiance llal accompanies a ieduclion in misspecilcalion Lias.
Impulse response con_dence intervals
!l las Lecome slandaid in lle macioeconomeliic lileialuie lo inleipiel VAR impulse iesponse
eslimales allei accounling loi sampling unceilainly. Tlis suLseclion lleieloie examines lle
implicalions ol lle cloice ol model-seleclion ciileiia loi conldence inleivals, iallei llan poinl
eslimales. To conseive space, iesulls loi only lwo impulse iesponse lunclions aie piesenled. Tle
iesulls loi lle ollei impulse iesponse lunclions aie qualilalively similai.
iguies 3 and 4 plol lle coveiage iales and aveiage lengll ol lle implied conldence inleivals
loi impulse iesponse lunclions 1 and 2. Tle lell column in iguie 3 plols lle liue impulse
iesponse lunclions. Tle ollei lwo columns plol lle eeclive coveiage iales ol lle S!C, HQC,
A!C
BC
, and A!C inleivals. As a ieleience poinl, lle plols also include lle coveiage ol lle same
inleival undei lle counleilaclual assumplion llal lle liue lag oidei is lnown. Lacl suLplol
slows lle eeclive coveiage iales ol lle nominal 95" inleivals loi a lime loiizon ol 16 peiiods
allei lle inilial slocl. A loiizonlal line al 0.95 would imply peilecl coveiage accuiacy al all lime
loiizons and las Leen imposed on lle plols as a ieleience line. Tle liue lag oidei inleival
ucluales aiound llis ideal value loi impulse iesponse 2, and comes veiy close loi impulse
iesponse 1. Tlis iesull is consislenl will evidence in Kilian (1998a) llal lle Lias-coiiecled
Loolsliap algoiillm peiloims quile well, il lle liue lag oidei is lnown. Howevei, in applied
woil lle lag oidei is iaiely lnown. A moie iealislic exeicise iecognizes llal lle lag oidei musl
Le eslimaled liom lle dala Leloie llling a VAR. Tle middle column in iguie 3 slows llal loi
sample size 80 lle eecls ol lag oidei unceilainly can Le sliiling. Considei lisl lle S!C and A!C
inleivals. oi lle exponenlially decaying impulse iesponse lunclion in lle uppei panel lle
eeclive coveiage diops Ly up lo 0.47 il lle lag oidei p
0
is eslimaled Ly lle S!C and Ly up lo
0.13 il p
0
is eslimaled Ly lle A!C. oi lle cyclical impulse iesponse lunclion in lle lowei panel
lle eecls aie even moie diamalic. oi lle S!C, lle coveiage ol lle nominal 95" inleival
Lecomes exliemely eiialic and may diop as low as 3"; loi lle A!C, coveiage also Lecomes veiy
unslaLle and loi some lime loiizons lalls lo 71". Tle peals and liougls ol lle coveiage plol
ieecl lle oscillalion in lle undeilying liue impulse iesponse lunclion. Tle ielalive peiloimance
ol lle S!C and A!C is exaclly as conjecluied, and consislenl will lle evidence loi lle poinl
eslimales.
Tle iigll column ol iguie 3 slows llal il lle sample size is iaised lo 160, lle eeclive coveiage
ol lle A!C inleivals is quile close lo nominal coveiage loi lle cyclical as well as lle smoollly
decaying impulse iesponse lunclion. !n slaip conliasl, lle coveiage ol lle S!C inleival sligllly
deleiioiales in lle uppei panel, and only somewlal impioves in lle lowei panel. Wlile ils
coveiage iales Lecome moie slaLle loi lle cyclical impulse iesponse lunclion, lle coveiage ol
lle S!C inleival may slill Le as low as 27", even loi sample size 160. Lslimaling lle lag oidei
Ly lle S!C iallei llan lle A!C can ieduce coveiage Ly as mucl as 69 peicenlage poinls, despile
lle laiily laige sample size. Tle inluilive explanalion is llal lle S!Clag oidei eslimale appaienlly
conveiges moie slowly llan lle impulse iesponse eslimales. Tle lowei coveiage ol lle S!C
inleival will liglei sample size aiises Lecause lle conldence inleival conveiges condilional on
p` p
0
, Lul nol necessaiily lo lle liue value ol lle impulse iesponse coemcienl. Tlis lnding is
170 1. Kilian
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Inpulsc Tcsponsc Hnalysis in 1HTs 171

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172 1. Kilian
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
consislenl will lle poinl made Ly KaLaila (1995) and Po lsclei (1995) llal lle coveiage ol lle
S!C-Lased inleival may Lecome aiLiliaiily small in lnile samples.
!l is also insliuclive lo compaie lle aveiage lengll ol lle inleivals. oi sample size 80, lle
A!C inleival in iguie 4 is sligllly sloilei llan lle liue lag oidei inleival in lle uppei panel,
and somewlal sloilei in lle lowei panel. Tlis evidence is iouglly consislenl will lle coveiage
iesulls in iguie 3. Howevei, lle S!C inleival is mucl sloilei llan lle liue lag oidei inleival.
Consideiing ils coveiage delciencies, llis lendency is evidence llal undeillling lle lag oidei
pioduces inleivals llal giossly undeislale lle liue exlenl ol sampling unceilainly. oi sample
size 160, lle Lasic pallein ol lle iesulls is pieseived. Tle S!Cinleival is slill loo sloil. !n conliasl,
lle A!C inleival las aLoul lle same lengll as lle liue lag oidei inleival in Loll panels. Tlis
pallein is consislenl will lle iesulls in TaLle !. As expecled, A!C inleivals aie only sligllly less
emcienl llan lle counleilaclual inleivals Lased on p
0
. Oveieslimalion ol p
0
evidenlly is nol a
seiious pioLlem.
!n addilion, similai Monle Cailo expeiimenls weie conducled loi lle HQC and lle A!C
BC
.
Since lle HQC lag oidei disliiLulion in TaLle ! is moie Lalanced llan lle disliiLulion ol lle
S!C lag oidei eslimale, one would expecl lle HQC inleival lo peiloim Lellei llan lle S!C
inleival. Monle Cailo simulalion conlims llis conjecluie. oi sample size 80, lle coveiage iales
ol lle HQC inleival exceed lle coiiesponding S!C iales Ly up lo 0.15 loi lle smoollly decaying
impulse iesponse lunclion, and Ly up lo 0.35 loi lle oscillaling impulse iesponse lunclion. oi
sample size 160, lle HQC inleival conveiges iapidly, and ils coveiage is al mosl 0.12 sloil ol
nominal coveiage. Tle impiovemenl in coveiage is consislenl will lle evidence in TaLle ! llal
lle HQC undeieslimales lle lag oidei mucl less liequenlly llan lle S!C. Howevei, as expecled,
lle peiloimance ol lle HQC inleival slill lalls lai sloil ol lle A!C inleival. As a lnal clecl
considei lle A!C
BC
inleival. Based on TaLle !, one would expecl lle A!C
BC
inleival lo Le less
accuiale in small samples llan lle A!C inleival, Lul moie accuiale llan lle S!C and HQC
inleivals. Monle Cailo simulalion again conlims llal conjecluie. Tle A!C
BC
inleival peiloims
aLoul as well as lle A!C inleival loi sample size 160, Lul las lowei coveiage loi sample size 80
Ly as mucl as 0.24. Al lle same lime, il cleaily dominales lle S!C and HQC inleivals. !nlei-
eslingly, lle lacl llal lle A!C
BC
succeeds in ieducing lle lendency ol lle A!C lo oveill lle
model, as inlended Ly ils ciealois, iallei llan Leing a viilue, Lecomes a liaLilily in lle piesenl
conlexl, as lle A!C
BC
is moie lilely lo undeill lle model loi sample size 80 and lo miss lle
liglei-oidei dynamics ol lle impulse iesponse lunclion.
Tle ielalive peiloimance ol lle loui lag oidei seleclion ciileiia malcles lle iesulls loi lle
poinl eslimales and is consislenl will lle view llal lle eecl ol misspecilying lle lag oidei is
sliongly asymmeliic, depending on wlellei lle model is undeill oi oveill. Since undeill
models ollen imply disloiled impulse iesponses, lle coveiage accuiacy ol lle inleivals is diieclly
coiielaled will lle pioLaLilily ol undeieslimaling lle lag oidei. !n pailiculai, loi sample size
80, lle A!C inleival (will pr(p` p
0
) 0.26) is mosl accuiale, lollowed Ly lle A!C
BC
inleival
(0.50), lle HQCinleival (0.67), and lle S!Cinleival (0.98). oi sample size 160, lle A!Cinleival
(0.01) ianls lisl, lollowed Ly lle A!C
BC
inleival (0.02), lle HQC inleival (0.12), and lle S!C
inleival (0.73).
D!SC!SS!O
Pievious Monle Cailo sludies usually locused on lle queslion ol wlicl lag oidei seleclion
ciileiion is lilely lo selecl lle liue lag oidei mosl ollen (e.g. iclelsLuig, 1985). Resulls loi lle
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
Inpulsc Tcsponsc Hnalysis in 1HTs 173
lag oidei disliiLulion may Le ol lleoielical inleiesl, Lul lley aie ol limiled inleiesl loi applied
useis inleiesled in VARslalislics sucl as loiecasls, impulse iesponses oi vaiiance decomposilions.
Tlis papei aigues llal loi applied woil, a moie uselul ciileiion loi compaiing alleinalive lag
oidei seleclion ciileiia is lle MSL ol lle slalislics ol inleiesl. ole llal lle ielalive liequency
disliiLulion ol lag oideis loi a given piocess does nol allow us lo piedicl a priori wlicl ciileiion
will imply lle smallesl MSL loi loiecasls, impulse iesponses, and ollei slalislics ol inleiesl and
low llese MSLs will vaiy will lle loiecasl loiizon. oi example, il is quile possiLle llal
undeieslimalion impioves lle MSL ielalive lo lle model Lased on lle liue lag oidei (see
Iu llepoll, 1985). !l is also possiLle llal adding exlia lags las lillle eecl on lle MSL ol non-
lineai lunclions ol VAR slope paiameleis sucl as impulse iesponses. !nlile iclelsLuig (1985),
we lleieloie locus diieclly on lle MSLs ol lle slalislic ol inleiesl.
We illusliale oui poinl in lle conlexl ol impulse iesponse analysis. Tle woil mosl closely
ielaled lo ouis is Iu llepoll (1985, 1991) wlo, Lased on lle MSLs ol sloil-iun loiecasls,
lenlalively concluded llal lle S!C peiloims Lesl in small samples. Tlis papei slows llal
Iu llepoll`s iesulls loi sloil-iun loiecasls do nol necessaiily exlend lo slalislics involving liglei-
oidei dynamics sucl as impulse iesponse lunclions. !n lacl, oveily paisimonious models may
complelely miss lle liglei-oidei dynamics ol lle impulse iesponse lunclion and yield seveiely
misleading conldence inleivals. !n piaclice, lle ieduclion in vaiiance liom llling moie pai-
simonious models is oulweigled Ly lle inciease in misspecilcalion Lias. As a iesull, applied
ieseaicleis inleiesled in policy analysis oi mulli-slep-alead loiecasls Lased on small samples aie
Lellei seived Ly less paisimonious ciileiia, even il llose ciileiia aie nol consislenl eslimalois ol
lle lag oidei. A similai poinl las Leen made Ly Haidle and Bowman (1988) in lle conlexl ol
non-paiameliic iegiession. Tley lnd llal lle Landwidll loi non-lineai and oscillaling cuives
musl Le adapled lo lle local cuivaluie lo ieduce lle Lias in cuive eslimalion. !n lleii iegiession
model, excessive smoolling eliminales lle liglei-oidei dynamics ol lle undeilying cuive. !n lle
VAR model, lle lag oidei plays lle iole ol lle Landwidll paiamelei, and undeieslimaling lle
lag oidei similaily eliminales lle oscillalion in lle eslimales ol lle undeilying impulse iesponse
cuive.
!l seems woill emplasizing llal lle simulalion evidence in llis papei only applies lo impulse
iesponse eslimales (and piesumaLly ielaled quanlilies lile vaiiance decomposilions oi mulli-
slep-alead piediclions). !l does nol imply llal lle A!C is a supeiioi lag oidei seleclion ciileiion
loi all puiposes. !n pailiculai, lle simulalion evidence in Iu llepoll (1985, 1991) loi some simple
aa hoc dala-geneialing piocesses suggesls llal loi sloil-iun loiecasls lle S!C oi lle HQC may
Le pieleiaLle. Tle evidence in llis papei loi a dala-geneialing piocess will mucl iiclei and
peilaps moie iealislic dynamics (judged Ly lle slape ol lle impulse iesponse lunclions) is
Lioadly consislenl will Iu llepoll`s iesulls, Lul il also slows llal lle polenlial advanlages ol
lle S!C al veiy sloil lime loiizons lend lo Le dwailed Ly seveie disloilions al lime loiizons
Leyond lve peiiods.
uilleimoie, lle iesulls in TaLle ! suggesl llal lle evidence in Iu llepoll (1985, 1991) ol lle
giealei accuiacy ol lle S!C in selecling lle liue lag oidei may lave Leen oveislaled. ole llal
lle dala-geneialing piocesses on wlicl llis conclusion las Leen Lased aie moslly VAR(1) models
(oi VAR(2) models will many elemenls ol lle coemcienl maliices sel lo zeio oi close lo zeio).
Tlis assumplion gieally lavouis paisimonious lag oidei seleclion ciileiia lile lle S!C will a
Luill-in Lias in small samples lowaid selecling a veiy low lag oidei, iegaidless ol lle liue lag
oidei. Tlis lacl laigely explains wly lle lag oidei eslimales in TaLle ! aie so mucl moie
lavouiaLle lo lle A!C llan pievious iesulls. To lle exlenl llal liglei-oidei dala-geneialing
174 1. Kilian
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
piocesses lile lle one used in llis papei aie moie iealislic llan pievious models, lle lndings ol
llis papei seem lo Le ol giealei ielevance loi applied woil. Tle ielalively good peiloimance ol
lle A!C in oui example is no guaianlee ol success, lowevei. Tleie is a lendency loi all ciileiia,
including lle A!C, lo undeill lle VAR model in snall sanplcs, especially loi liglei-oidei dala-
geneialing piocesses.
Tle emplasis in llis papei on longei lime loiizons also iaises lle queslion ol lle appio-
piialeness ol model-seleclion ciileiia designed lo minimize one-slep-alead piediclion eiioi vaii-
ances. Wlile ciileiia lile lle A!C seem lo woil ieasonaLly well in piaclice, lleii molivalion loi
impulse iesponse analysis seems awlwaid and alleinalive designs loi model-seleclion ciileiia
may yield luillei impiovemenls. oi example, one could imagine ie-eslimaling lle model will
dieienl lag oideis depending on lle lime loiizon ol inleiesl oi specilying an explicil loss
lunclion loi a given lime loiizon.
!l is inleiesling lo conliasl lle use ol inloimalion-Lased lag oidei seleclion ciileiia will lle
use ol Bayesian piiois loi lle lag sliucluie. !l is common in Bayesian VAR analysis lo specily
some iale ol decay loi lle lag oidei weiglls will a lnile uppei Lound. Ieaving aside lle queslion
ol wleie lag oidei piiois come liom in piaclice, llis appioacl is cleaily moie exiLle llan lle
iigid piiois implicil in inloimalion-Lased ciileiia sucl as lle S!C. oi example, lle use ol slowly
decaying lag weiglls in Bayesian analysis allows consideialion ol liglei lag oideis and avoids
slaip cul-o poinls. Tlus, liom a Bayesian poinl ol view, lag oidei eslimales Lased on inloi-
malion-Lased lag oidei seleclion ciileiia may simply ieecl unieasonaLle piiois aLoul lle lag
oidei weiglls. Tley impose eillei loo many oi nol enougl iesliiclions on lle lag sliucluie. Tlis
does nol mean llal lle iesulls ol llis papei aie ol no use loi Bayesian analysis. Tle Lasic liados
llis papei las documenled conlinue lo apply in any VAR analysis, wlellei lle lag oidei is
selecled aa hoc, Lased on model-seleclion ciileiia, oi Lased on loimal piiois. oi example, Ly
cloosing a iale ol decay llal is loo lasl, a Bayesian lag oidei piioi may oveismooll lle impulse
iesponse lunclions in mucl lle same way llal liuncaling lle lag oidei in classical analysis would.
Tle dieience is only a mallei ol degiee. Tle same applies lo lle seleclion ol lle uppei Lound
loi lle lag sliucluie. !l llal piioi cul-o poinl is closen loo low, lle MSLol lle impulse iesponse
eslimales will Le adveisely aecled mucl as in lle case ol lle S!C oi HQC.
inally, il appeais llal some applied VAR useis simply iely on convenlional lag oidei cloices
(say, 4 oi 8 lags loi quaileily dala, 6 oi 12 lags loi monllly dala) iallei llan explicilly eslimaling
lle lag oidei liom lle dala. Tle iesulls ol llis papei suggesl llal in llal case il appeais lo Le
salei lo eii on lle side ol including exlia lags iallei llan lo liuncale lle lag oidei polynomial
loo eaily. We noled llal even lle A!C is lilely lo undeieslimale lle lag oidei in small samples.
!l lle A!C lag oidei eslimale appeais counleiinluilively low, as is ollen lle case in applied woil,
a ieseaiclei may Le jusliled in consideiing even liglei lag oideis llan suggesled Ly lle A!C.
APPI!CAT!O: THL LLCTS O MOLTARY POI!CY
Tle Monle Cailo evidence piesenled aLove suggesls llal lle cloice ol lag oidei seleclion ciileiion
can lave impoilanl eecls on slalislical accuiacy. To eslaLlisl llal llese slalislical dieiences
may Le impoilanl enougl lo aecl lle economic inleipielalion ol lle eslimaled VAR model in
ieal-lile applicalions iequiies addilional evidence. Tlis seclion piesenls one sucl ieal-lile appli-
calion Lased on LiclenLaum (1992). LiclenLaum sludies lle eecls ol monelaiy policy on lle
!S economy Lased on impulse iesponses loi a vaiiely ol VAR models, including a loui-vaiiaLle
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
Inpulsc Tcsponsc Hnalysis in 1HTs 175
VAR will inleicepl Lased on monllly dala loi 1965:11990:1. Tle oideiing ol lle vaiiaLles is
indusliial pioduclion, consumei piices, M1, and lle edeial unds iale. All dala Lul lle inleiesl
iale aie in logs. oi Loll lag oidei seleclion ciileiia lle uppei and lowei Lounds on lle lag oidei
weie speciled as 1 p 12. Tle S!C selecls a lag oidei ol lwo, wleieas lle A!C selecls a lag
oidei ol eigll.
iguie 5 plols lle 95"conldence inleivals (uppei panel) and 68"conldence inleivals (lowei
panel) loi selecled iesponses lo an unanlicipaled iise in M1. To avoid nolalional clullei, only
lle conldence inleivals Lased on lle A!Cand S!Caie slown. As lle sign ol lle impulse iesponse
eslimale is piimaiily deleimined Ly lle lisl-oidei auloiegiessive coemcienls, one would expecl
lle S!C and A!C inleivals lo lypically move in lle same diieclion. Howevei, lle S!C can Le
expecled lo ignoie lle liglei-oidei dynamics ol lle impulse iesponse. As a iesull, S!C inleivals
will Le smoollei and lypically ligllei llan A!C inleivals. Tlese dieiences aie impoilanl,
Lecause ollen analysls aie inleiesled in lle magnilude ol impulse iesponses in addilion lo lleii
diieclion. oi example, in lle uppei panel lle iesponse ol M1 lo a monelaiy expansion is liglly
peisislenl accoiding lo lle S!C, Lul one cannol iejecl llal il decays quiclly accoiding lo lle
A!C. Similaily, lle iesponse ol lle piice level is signilcanlly posilive undei lle A!C, Lul nol
signilcanlly dieienl liom zeio undei lle S!C. !n geneial, A!C inleivals aie mucl widei,
especially al liglei lime loiizons, indicaling suLslanlially liglei sampling unceilainly aLoul lle
eecls ol monelaiy policy. !n lacl, lle inleival widll somewlal oLscuies lle dieiences Lelween
lle S!Cand A!Cin lle uppei panel. Tle lowei panel ol iguie 5 lleieloie plols lle coiiesponding
68" inleivals loi lle same iesponses. ole llal lle iesponse ol M1 now is sliongly signilcanl
and liglly peisislenl accoiding lo lle S!C, Lul slill insignilcanl loi lime loiizons ol lwo yeais
oi liglei accoiding lo lle A!C. !n conliasl lo lle eailiei lndings, lle iesponse ol oulpul lo a
monelaiy expansion is signilcanlly negalive Lased on lle A!C, Lul nol Lased on lle S!C. Tlis
lnding is impoilanl, Lecause lle negalive iesponse ol oulpul was one ol lle ley ieasons wlicl
led LiclenLaum lo iejecl llis pailiculai model. Ollei signilcanl dieiences Lelween lle S!C and
A!C aiise loi lle iesponses ol lle piice level and lle ed unds iale. oi example, lle iesponse
ol lle piice level lo a monelaiy expansion iemains signilcanl loi almosl lwice as long accoiding
lo lle A!C compaied lo lle S!C. Tlese iesulls slow llal despile lle inciease in inleival widll,
using lle A!C iallei llan moie paisimonious ciileiia does nol iendei VAR impulse iesponse
analysis lulile. Moieovei, lle A!C may convey a quile dieienl picluie ol wlicl iesponses aie
signilcanl and al wlal lime loiizons.
Tle evidence in iguie 5 does nol lell us wlicl mellod is moie ieliaLle in llis pailiculai
model. Tlal queslion could only Le answeied Ly a Monle Cailo sludy (lle compulalional cosl
ol wlicl is lilely lo Le pioliLilive). Howevei, iguie 5 illusliales lle gieal piaclical impoilance
ol lnding ieliaLle lag oidei seleclion ciileiia loi inleience Lased on VAR model eslimales.
COCI!S!O
Tle papei piovides evidence ol lle liade-os Lelween loui commonly used inloimalion-Lased
lag oidei seleclion ciileiia: lle S!C, HQC, A!C
BC
, and A!C. !l is widely Lelieved llal sliongly
consislenl lag oidei seleclion ciileiia sucl as lle S!Cand lle HannanQuinn Ciileiion aie Lellei
suiled loi VAR analysis llan less paisimonious ciileiia sucl as lle A!C, il lle liue lag oidei is
lnile. !n conliasl, lle A!C is iegaided as moie ieliaLle loi inlnile-oidei auloiegiessions. Tle
176 1. Kilian
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)

i
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Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
Inpulsc Tcsponsc Hnalysis in 1HTs 177
novel conclusion ol llis papei was llal cvcn in lnile-oidei VARmodels in many cases ol piaclical
inleiesl lle A!C is lilely lo Le pieleiaLle lo lle S!C oi HQC.
Tle papei emplasized lle lacl llal lle eecls ol model misspecilcalion in small samples aie
sliongly asymmeliic depending on wlellei lle model is undei- oi oveill, il inleiesl cenlies on
VAR slalislics involving liglei-oidei dynamics sucl as impulse iesponse lunclions, vaiiance
decomposilions, measuies ol piediclaLilily, oi long-leim loiecasls. !n leims ol lle MSL, one
would lleieloie expecl less paisimonious ciileiia lile lle A!Clo iesull in moie accuiale eslimales
and inleience llan sliongly consislenl lag oidei seleclion ciileiia lile lle S!C and HQC llal
lave a sliongei lendency lo undeieslimale lle lag oidei in lnile samples. A Monle Cailo sludy
illuslialed lle polenlial quanlilalive impoilance ol llis poinl. !l was lound llal lle MSLs ol
impulse iesponse eslimales Lased on lle A!C lend lo Le suLslanlially lowei llan loi eslimales
Lased on moie paisimonious ciileiia. Similaily, impulse iesponse conldence inleivals Lased on
lle A!C lag oidei eslimale lended lo Le Ly lai lle mosl accuiale inleivals. !n conliasl, lle S!C
eslimales lypically missed lle liglei-oidei dynamics in impulse iesponse lunclions and ollen
iesulled in seveiely misleading and spuiiously ligll inleival eslimales, even loi laiily laige
samples.
Tle aim ol llis papei las Leen lo iaise lle awaieness ol applied ieseaicleis ol lle implicil
liade-os in lle use ol lag oidei seleclion ciileiia and lo ie-open lle deLale ovei model seleclion
Ly demonslialing llal paisimony is nol necessaiily a viilue. !l was demonslialed llal applied
ieseaicleis need lo give caielul llougll lo lle lag oidei cloice Lecause in many piaclical
applicalions paisimony ol lle model may oLscuie lle liue dynamics. Tleie aie seveial diieclions
loi luluie ieseaicl. iisl, lle cloice ol model-seleclion ciileiion involves an implicil liadeo
Lelween localion (oi Lias) and scale (oi vaiiance) eecls. Tlis liadeo may diei depending on
lle sample size, lle loiecasl loiizon, and lle slalislic ol inleiesl. uillei ieseaicl is needed lo
idenlily llese liadeos in model seleclion loi ollei slalislics, models, and lime loiizons.
Second, an impoilanl exlension would Le lo geneialize lle iesulls lo auloiegiessive models
will possiLly inlnile lag oidei. Tle common assumplion llal lle liue model is conlained among
a sel ol lnile oidei VAR models is cleaily uniealislic. Wlile lle iesulls in llis papei only apply
lo lnile lag oidei piocesses, in piaclice, one would nol expecl lundamenlal dieiences in iesulls
Lelween liglei-oidei VAR(p) and inlnile oidei VAR models, as lle loimei may Le viewed as
an appioximalion ol lle lallei. Some pieliminaiy woil on lag oidei seleclion in inlnile-oidei
piocesses las Leen piesenled Ly Beilowilz, Biigean, and Kilian (1999).
A lliid exlension would Le lo allow loi lle eecls ol lag oidei unceilainly in inleience. Tlis
papei las documenled llal coveiage iales ol conldence inleivals may diop diaslically il lle lag
oidei is unlnown and las lo Le eslimaled liom lle dala. Pail ol lle pioLlem is llal slandaid
inleience ignoies lle unceilainly associaled will lle lag oidei eslimale in lnile samples (see
Po lsclei, 1991). Kilian (1998L) examines a modiled Loolsliap algoiillm wlicl accounls loi lle
lacl llal lle lag oidei is deleimined Lased on lle same dala sel used loi lle eslimalion ol lle
VAR model. Tlis modilcalion can Le slown lo suLslanlially enlance lle coveiage accuiacy ol
Loolsliap conldence inleivals in many cases.
APPLD!X: THL O-PARAMLTR!C B!AS-CORRLCTLD BOOTSTRAP
AIGOR!THM O K!I!A (1998a)
Iel CE(b b) b(b ),TO(T
3,2
), wleie b denoles lle OIS eslimale ol b (see Pope, 1990).
Given lle assumplions ol lle second seclion ol llis papei, undei some iegulaiily condilions, a
178 1. Kilian
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
Lias-coiiecled Loolsliap conldence inleival loi llis impulse iesponse eslimale may Le con-
sliucled as lollows:
, Sicp 0a: Deleimine lle lag oidei p Ly an appiopiiale model seleclion ciileiion sucl as lle A!C
and ll a VAR(p`) model lo lle dala "y
i
#. Lslimale b and calculale lle lisl-oidei Lias C b(b ),T
using lle closed-loim solulion given in Pope (1990).
, Sicp 0b: Tle companion maliix is lle auloiegiessive coemcienl maliix oLlained Ly expiessing
lle N-dimensional VAR(p) piocess as an N p-dimensional VAR(1) piocess (see Iu llepoll,
1991, p. 11). Calculale lle modulus ol lle laigesl iool ol lle companion maliix associaled will
b . Denole lle modulus Ly n(b ). !l n(b ) 1, sel b b willoul any adjuslmenls. !l n(b ) 1,
consliucl lle Lias-coiiecled coemcienl eslimale b b C. !l n(b ) 1, lel C
1
C and d
1
1
and delne C
i 1
d
i
C
i
and d
i 1
d
i
0.01. Sel b b
i
allei ileialing on b
i
b C
i
loi
i 1, 2, . . . , unlil n(b
i
) 1. By clanging lle giid loi d, one can male n(b ) aiLiliaiily close lo
unily. Tle puipose ol llis slalionaiily coiieclion is lo avoid pusling slalionaiy impulse iesponse
eslimales inlo lle non-slalionaiy iegion. Tle adjuslmenl las no eecl asymplolically and does
nol iesliicl lle paiamelei space ol lle OIS eslimaloi, since il does nol sliinl lle OIS eslimale
b ilsell, Lul only ils Lias eslimale.
, Sicp 1a: !sing slandaid non-paiameliic iesampling leclniques, geneiale T Loolsliap iep-
licalions "y
i
# ol "y
i
# Lased on lle iecuision:
y
i
B
1
y
i1
B
2
y
i2
. . . B
p`
y
ip`
u
i
oi eacl Loolsliap ieplicalion "y
i
#, ll a VAR(p`) lo "y
i
#. Lslimale b and s`
u
and consliucl
lle lisl-oidei Lias eslimale C b(b ),T.
, Sicp 1b: Calculale lle Lias-coiiecled eslimale b liom b and C lollowing lle insliuclions in
slep 1L will lle oLvious clanges in nolalion.
, Sicp 2: Read o lle a and 1a peicenlile inleival endpoinls ol lle disliiLulion ol lle Loolsliap
impulse iesponse eslimale u
kl,i
(b , s

, p`).
ACKOWILDGLMLTS
! llanl lle ediloi, lle associale ediloi, BoL Baisly, Iaiiy Cliisliano, ianl DieLold, Plil
Howiey, BoL Sline, Cliis Sims, Tao Zla and lwo anonymous ieleiees loi lelplul discussions
and commenls on an eailiei veision ol llis papei.
RLLRLCLS
Beilowilz 1, Biigean !, Kilian I. 1999. On lle lnile-sample accuiacy ol nonpaiameliic iesampling algo-
iillms loi economic lime seiies. oillcoming in Havanccs in Econoncirics] Hpplying Kcrncl ana Non-
paranciric Esiinaiion io Econonic Topics, omLy TB, Hill RC (eds). 03.
LiclenLaum M. 1992. Commenls !nleipieling lle macioeconomic lime seiies lacls: lle eecls ol monelaiy
policy` Ly Cliisloplei Sims. Europcan Econonic Tcvicw 25: 10011011.
Giangei CW1, King MI, Wlile H. 1995. Commenls on lesling economic lleoiies and lle use ol model
seleclion ciileiia. 1ournal of Econoncirics 56: 173187.
Haidle W, Bowman A. 1988. Boolsliapping in nonpaiameliic iegiession: local adaplive smoolling and
conldence Lands. 1ournal of ihc Hncrican Siaiisiical Hssociaiion 72: 102110.
Copyiigll 2001 1oln Wiley & Sons, Ild. 1. Forccasi. 19, 161179 (2001)
Inpulsc Tcsponsc Hnalysis in 1HTs 179
Hannan L1, Quinn BG. 1979. Tle deleiminalion ol lle oidei ol an auloiegiession. 1ournal of ihc Toyal
Siaiisiical Sociciy B 30: 190195.
Huivicl CM, Tsai C-I. 1993. A coiiecled Alaile !nloimalion Ciileiion loi vecloi auloiegiessive model
seleclion. 1ournal of Tinc Scrics Hnalysis 03: 271279.
KaLaila PM. 1995. Tle eecl ol model seleclion on conldence iegions and piediclion iegions. Econonciric
Thcory 00: 537549.
Kilian I. 1998a. Small-sample conldence inleivals loi impulse iesponse lunclions. Tcvicw of Econonics
ana Siaiisiics 79: 218230.
Kilian I. 1998L. Accounling loi lag oidei unceilainly in auloiegiessions: lle endogenous lag oidei Lool-
sliap algoiillm. 1ournal of Tinc Scrics Hnalysis 08: 531548.
Iu llepoll H. 1985. Compaiison ol ciileiia loi eslimaling lle oidei ol a vecloi auloiegiessive piocess.
1ournal of Tinc Scrics Hnalysis 5: 3552.
Iu llepoll H. 1991. Iniroauciion io Muliiplc Tinc Scrics Hnalysis. Spiingei-Veilag: ew Yoil.
iclelsLuig G. 1985. Small-sample piopeilies ol dimensionalily slalislics loi llling VAR models lo aggie-
gale economic dala. A Monle Cailo sludy. 1ournal of Econoncirics 17: 183192.
isli R. 1988. Maximum lilelilood piinciple and model seleclion wlen lle liue model is unspeciled.
1ournal of Muliivariaic Hnalysis 16: 392403.
Paulsen 1, Tjo slleimD. 1985. On lle eslimalion ol iesidual vaiiance and oidei in auloiegiessive lime seiies.
1ournal of ihc Toyal Siaiisiical Sociciy B 36: 216228.
Pope AI. 1990. Biases ol eslimalois in mullivaiiale non-Gaussian auloiegiessions. 1ournal of Tinc Scrics
Hnalysis 00: 249258.
Po lsclei BM. 1991. Lecls ol model seleclion on inleience. Econonciric Thcory 6: 63185.
Po lsclei BM. 1995. Commenl on Tle eecl ol model seleclion on conldence iegions and piediclion
iegions` Ly P. KaLaila. Econonciric Thcory 00: 550559.
Quinn BG. 1980. Oidei deleiminalion loi a mullivaiiale auloiegiession. 1ournal of ihc Toyal Siaiisiical
Sociciy B 31: 182185.
Quinn BG. 1988. A nole on A!C oidei deleiminalion loi mullivaiiale auloiegiessions. 1ournal of Tinc
Scrics Hnalysis 8: 241245.
SliLala R. 1976. Seleclion ol lle oidei ol an auloiegiessive model Ly Alaile`s !nloimalion Ciileiion.
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SliLala R. 1980. Asymplolically emcienl seleclion ol lle oidei ol lle model loi eslimaling paiameleis ol a
lineai iegiession. Hnnals of Siaiisiics 7: 147164.
SliLala R. 1983. A lleoielical view ol lle use ol lle A!C. !n Time Seiies Analysis: Tleoiy and Piaclice 4,
Andeison OD (ed.). Llseviei,oill-Holland: Amsleidam; 237244.
SliLala R. 1986. Consislency ol model seleclion and paiamelei eslimalion. !n Lssays in Time Seiies and
Allied Piocesses, Gani 1, Piieslley MB (eds). Applied PioLaLilily Tiusl: Slemeld; 127141.
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Huihors biography:
Lutz Kilian is Assislanl Piolessoi ol Lconomics al lle !niveisily ol Micligan and Reseaicl Amliale al lle
Cenlie loi Lconomic Policy Reseaicl, Iondon, !K. He lolds a PlD in economics liom lle !niveisily ol
Pennsylvania. His cuiienl ieseaicl inleiesls include empiiical macioeconomics and Loolsliap inleience loi
lime seiies. His ailicles lave appeaied in Havanccs in Econoncirics, Econonciric Tcvicws, 1ournal of Hpplica
Econoncirics, 1ournal of Busincss ana Econonic Siaiisiics, 1ournal of Moncy, Crcaii ana Banking, 1ournal
of Tinc Scrics Hnalysis, and Tcvicw of Econonics ana Siaiisiics.
Huihors aaarcss: Lutz Kilian, Depailmenl ol Lconomics, !niveisily ol Micligan, Ann AiLoi, M! 48109-
1220, !SA.