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IDENTIFICATION METHODS IN VECTOR-ERROR CORRECTION MODELS: EQUIVALENCE RESULTS

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Abstract

In a structural vector-error correction (VEC) model, it is possible to decompose the shocks into those with permanent and transitory effects on the levels of the variables. Pagan and Pesaran derive the restrictions which the permanent–transitory decomposition of the shocks imposes on the structural VEC model. This paper shows that these restrictions are equivalent to a set of restrictions that are applied in the methods of Gonzalo and Ng and King et al. (KPSW). Using this result, it is shown that the Pagan and Pesaran method can be used to recover the structural shocks with permanent effects identically to those from the Gonzalo and Ng and KPSW methods. In the former case, this is illustrated in the context of Lettau and Ludvigson's consumption model and in the latter case in KPSW's six variable model. There are also two other methods for which the Pagan and Pesaran approach can deliver identical permanent shocks which are also discussed.

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