The Effect of a Financial Block on the Identification of Confidence Shocks in a Structural VAR Model

Myohl, Christian (August 2018). The Effect of a Financial Block on the Identification of Confidence Shocks in a Structural VAR Model (Discussion Papers 18-21). Bern: Department of Economics

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This paper studies the propagation and properties of a confidence shock in a structural vector autoregression (VAR) model with and without financial variables. The addition of a financial block does not considerably change the propagation and the contribution to the forecast error variance by the confidence shock. Nevertheless, for specific historical episodes, the inclusion of a financial block plays a role. In several recessions, the VAR with the financial block assigns a smaller role to confidence shocks for the fall in GDP. This suggests that the confidence shock may not be properly identified in a structural VAR when financial variables are omitted. Further, I identify a financial channel by which the confidence shock affects economic activity.

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