FAVAR vs VAR

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mpazbraun
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Joined: Thu Jul 13, 2017 7:34 am

FAVAR vs VAR

Postby mpazbraun » Thu Jul 27, 2017 9:07 am

Hi,
I hope you are keeping well. Please I am sorry to bother you, but I need to see the light regarding an issue.

I am doing a brief analysis about Brazil's stock market volatility return and macro volatility.
I have 5 group of variables (output, employment, interest rate, default, money supply), in total, 40 variables.

My goal is to evaluate how stock market respond to macro volatility shocks. So far, I got the first latent factor (principal component) of each macro group and then, I ran a standard VAR employing only those key latent factors:
example: stock return volatility vs PC1 PC2 PC3 PC4 PC5, where PC1: first component output group

So my question if this approach is correct and what is the main difference in comparison with a FAVAR approach. I understand that FAVAR method has a formal framwork, but also has the same intuition (more information, better forecast).

please your comments.
thanks a lot
Best regards.
MPBraun

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