Frequency-Domain Estimation as an Alternative to Pre-Filtering External Cycles in Structural VAR Analysis

Abstract

This paper shows that the frequency domain estimation of VAR models over a frequency band can be a good alternative to pre-filtering the data when a low-frequency cycle contaminates some of the variables. As stressed in the econometric literature, pre-filtering destroys the low-frequency range of the spectrum, leading to substantial bias in the responses of the variables to structural shocks. Our analysis shows that if the estimation is carried out in the frequency domain, but employing a sensible band to exclude (enough) contaminated frequencies from the likelihood, the resulting VAR estimates and the impulse responses to structural shocks do not present significant bias. This result is robust to several specifications of the external cycle and data lengths. An empirical application studying the effect of technology shocks on hours worked is provided to illustrate the results. Keywords: Impulse-response, filtering, identification, technology shocks. JEL Classification: C32, C51, E32, E37