About Local Projection Impulse Response Function Reliability

Abstract

I compare the performance of the VAR impulse response function (IRF) estimator with the Jordà (2005) local projection (LP) methodology. I show by a Monte Carlo exercise that when the data generating process (DGP) is a well-specified vector autoregressive model (VAR), the standard estimator is a better alternative. However, in the general case in which the sample size is small, and the lag length of the model is misspecified, the local projection estimator is a competitive alternative to the standard VAR impulse response function estimator. Along the way, I highlight some lack in the local projection literature, which can lead to potential improvement in the estimation procedure.

Publication
CEIS Research Paper, Vol. 16, Issue 6, No. 440
Date