TIME SERIES

ECONOMETRICS
STRUCTURAL VAR: THE AB MODEL
Structural VAR representation
Suppose we have the following bivariate VAR(1) model of the
following form (Note: we suppress the intercept term for
simplicity):
yt  a12 xt  11 yt 1  12 xt 1  b11u1t
xt  a21 yt   21 yt 1   22 xt 1  b22u2t
In the framework, y and x are specified to be related
contemporaneously as well as with lags and u1t and u2t are
structural shocks of yt and xt respectively and
u1t   0  1 0 
u  ~ N  ,  
 2t   0   0 1

OLS estimation method may not be used to estimate the above

since the error terms are correlated with the right-hand-side
contemporaneous variables.
SVAR and Reduced-Form VAR
• Expressing (1) and (2) in matrix notation, we have:

 1 a12   yt  11 12   yt 1  b11 0  u1t  SVAR or

a          u  primitive
 21 1 x  
  t   21 22   t 1  
x 0 b22   2t  VAR

• Rearranging terms:
1 1
 yt   1 a12  11 12   yt 1   1 a12  b11 0  u2t 
 x   a          
 t   21 1   21  22   xt 1  a21 1   0 b22  u2t 

 yt   11 12   yt 1   1t  Reduced form

 x         VAR/Tradition
 t   21  22   xt 1   2t  al VAR
Objectives of VAR Analysis
To uncover dynamic interactions among the variables
examined:
Two VAR approaches:
- minimal theoretical restrictions: traditional VAR
- theoretical identifying restrictions: Structural VAR
(Theoretic-dependent)
Similar analytical principle – analyzing the effects of
structural shocks on the variables under study.
Main issue in VAR/SVAR
The basic issue in VAR modeling is structural shock
identification.

1t  1  1  a12  b11 0  u1t 

  
 2t  1  a12a21
 a
 21 1   0 b22  u2t 
Note that, the reduced form errors make up of structural
errors. Accordingly, a shock to a reduced form “error”
cannot be taken as a structural shock to a particular
variable:
Structural shock identification
Note that:
1
1t   1 a12  b11 0  u1t   1 a12  1t  b11 0  u1t 
   a     a       A t  Bu t
 2t   21 1   0 b22  u2t   21 1   2t   0 b22  u2t 

This is AB model proposed by Amisano and Giannini (1997)).

Let B be an identity matrix. To just identify the structural shocks, the
number of restrictions on the off-diagonal elements of matrix A is n(n-
1)/2 since the estimated variance-covariance matrix of reduced form
residuals has n(n+1)/2 unique elements.
In general, the number of restrictions for exact identification is 2n2 -
n(n+1)/2 on A and B matrices.
Case 1: a12 = a21 = 0
• In this case, the contemporaneous value of x will not
appear in the y equation and, likewise, the
contemporaneous value of y will not be in the x equation.
Hence, the reduced form residuals are identical to
structural residuals (or shocks).

 1t  1 u1t  a12u 2t  1t  u1t 

    a u  u     u 
 2t  1  a12 a 21  21 1t 2t   2t   2t 
Case 2: a12 = 0
This is a recursive identification as suggested by
Sims(1980), the so-called Cholesky factorization.

1 0  1t  u1t   1t  u1t

a
 21 1  2t  u 2t   2t  a21u1t  u 2t
In this case, x is affected contemporaneously by
structural shock in y but not the reverse (y is also affected
by structural shock in x with lag).
Theoretical Restrictions
In general, the model contains more than two variables.
The essence of SVAR is to use theoretical restrictions to
identify the shocks.
Since these restrictions are theoretical-dependent,
illustration need to be given from the theoretical model
adopted to assess the relationship among the variables.

To be fruitful, the models involving more than two variables

will be used.
Example I: Kozluk and Mehrotra (2009)

Kozluk, T., and Mehrotra, A., (2009), The impact of monetary policy
shocks on East and South-east Asia. Economics of Transition, 17(1),
121-145.
Step I: Estimate the VAR
• The model contains 6 variable.
• The construction of the AB model and its restrictions
should be based on theories (see the paper).
• Estimate the 6-variable VAR model containing the six
variables (i.e. the reduced form VAR)
• It is suggested that the information criterion is used to the
determine the VAR lag order.
• This step is standard in any VAR analysis, i.e. an
estimation of the reduced-form VAR.
• From the reduced form VAR, a structural identification is
made.
Step II: Construct the A and B Matrices
• There are various ways to construct the A and B
matrices.
• Take note the matrices are square matrices with
the size equals to the number of endogenous
variables. In our case, it is 6.
• There are various ways to construct the matrices.
The simple way is to use matrix object.
• Click object/new object and choose Matrix-
Vector-Coef.
• Eviews will bring up the following (next page).
 Name of matrix:
MATA

After
Click
OK
Specify the size of
matrix
Fill in the restrictions
as specified in the
model with NA for the
value to be estimated
Close the Matrix Object. MATA
(i.e. Matrix A) will appear in
the workfile.

Construct Matrix B in the

same manner.
Step III: Estimate the structural
factorization
After the estimation of the VAR in Step I and
construction of the A and B matrices in step II,
proceed to estimate the AB model by estimating
structural factorization.
Do not close your VAR result window as the
structural factorization needs to be estimated
from there.
Click Proc/Estimate Structural Factorization.
Eviews will bring to…(next page).
Choose matrix
specification

Enter the name

of matrix A and
matrix B
previously
created.
Step IV: Generate IRF and VDC
• The previous step gives you the estimated of
contemporaneous relations as specified in the AB format.
• In order the generate the IRF and VDC based on your
identification scheme (the SVAR), make sure that the
impulse definition is STRUCTURAL DECOMPOSITION.
• Shock will be named as Shock 1, Shock 2 and so on
corresponding to the order of the variables entered when
estimating the VAR in the first step.